intro to econ part.2
DESCRIPTION
Intro to Econ Part.2TRANSCRIPT
Chapter 2Efficiency,
Exchange, and Comparative Advantage
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Outline
• Goods and Bads• The Myth of Material Wealth• Trade Creates Wealth• Is It Worth It? Efficiency and Values• Recognizing Trade-Offs: Comparing
Opportunity Costs of Production• The Gains from Specialization and Exchange
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Outline - continued
• Why Specialize?• From Individual Trade to International
Trade, and Back Again• Transactions Costs• Incentives to Reduce Transactions
Costs: Middlemen• Markets as Discovery Processes• The Big Picture: First Thoughts on
Economic Growth
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Introduction
• This chapter explores these questions:– Who profits from trading?– Is trade productive?– What are production possibilities?– What is wealth?– What is economic growth?
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Good and Bads
• A commodity is a good if more of it is preferred to less
• A commodity is a bad if less of it is preferred to more
• A free good can be acquired without sacrifice
• A scarce good requires sacrifice
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The Myth of Material Wealth
• Of what does wealth consist?
– wealth, in the economic way of thinking, is whatever people value
– value is in the eye of the chooser
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Trade Creates Wealth
• The myth of material wealth: economic growth consists not in increasing output of things, but increasing the generation of wealth
• “wealth equals material things” is not a valid claim, as it omits key aspects of economic life like “specialization” and “exchange” in Adam Smith’s commercial society
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Trade Creates Wealth
• Questions:– What do we gain from trading?– Is it accurate to say that the two goods
traded have equal value?– Does trade add value, wealth?– Is trading efficient?
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Trade Creates Wealth
TradeInvolves exchange to gain more of what people value
Voluntary exchange
Involves exchangeof unequally valued goods
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Trade Creates Wealth
example:does
exchange of a ball for a
glove, between two
people, affect wealth?
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Trade Creates Wealth
• With trade each party trades a less valued good for a more valued good
every choice entails a trade-off
• The cost of obtaining a good is the value placed on whatever is sacrificed to buy it
referred to as the opportunity cost
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Is It Worth It? Efficiency and Values
• Efficiency changes with valuations– efficiency compares the ratio of the value
of the output to the value of the input• Increased efficiency
leads to lower production costs
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Is It Worth It? Efficiency and Values
Efficiency =value of output
value of input
The efficiency of any processcan change with changes
in valuation
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Recognizing Trade-Offs: Comparing Opportunity Costs of Production
A Production Possibilities Frontier illustrates maximum combinations of products that can beproduced using a given set of resources and talent
A Production Possibilities Frontier illustrates maximum combinations of products that can beproduced using a given set of resources and talent
Jones:5 S = 10 L therefore1 S = cost 2 L and 1 L = ½ S
Jones:5 S = 10 L therefore1 S = cost 2 L and 1 L = ½ S
Brown:4 S = 3 L therefore1 S = cost ¾ L and 1 L = 4/3 S
Brown:4 S = 3 L therefore1 S = cost ¾ L and 1 L = 4/3 S
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Recognizing Trade-Offs: Comparing Opportunity Costs of Production
5
10
Jones
stout
lager
Production possibilities before specialization and tradeProduction possibilities before specialization and trade
stout
lager
Brown
4
3
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Recognizing Trade-Offs: Comparing Opportunity Costs of Production
• Who produces lager at a relatively lower cost?
– if Jones produces only lager he can make 10 gallons but sacrifices the opportunity to make 5 gallons of stout … if he makes only stout he sacrifices the opportunity to make 10 gallons of lager
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Recognizing Trade-Offs: Comparing Opportunity Costs of Production
– if Brown produces only stout she can make 4 gallons but gives up the opportunity to make 3 gallons of lager … for every gallon of stout she sacrifices ¾ gallons of lager
• Note that Jones can produce more of both stout (S) and lager(L)
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Table 2–1
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Recognizing tradeoffs: comparing opportunity costs of production
The tables show that Jones has a lower relative costproducing lager, he only sacrifices ½ S for each gallon of L, while Brown must forego 4/3 S for eachgallon of L.
The tables show that Jones has a lower relative costproducing lager, he only sacrifices ½ S for each gallon of L, while Brown must forego 4/3 S for eachgallon of L.
Jones:5 S= 10 L therefore1 S = cost 2 L and 1 L = ½ S
Jones:5 S= 10 L therefore1 S = cost 2 L and 1 L = ½ S
Brown:4 S= 3 L therefore1 S = cost ¾ L and 1 L = 4/3 S
Brown:4 S= 3 L therefore1 S = cost ¾ L and 1 L = 4/3 S
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Recognizing Trade-Offs: Comparing Opportunity Costs of Production
• Who produces lager at a relatively lower cost?– The least cost producer of a product has a
comparative advantage over other producers, due to lower opportunity cost
– The tables show that Jones has a comparative advantage in L, while Brown has a comparative advantage in S
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The Gains from Specialization and Exchange
If Brown and Jonesagree to trade one for one
in the product of theircomparative advantage:
Jones can enjoy 7 lager and 3
stout …Brown can enjoy
3 lager and 1 stout
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The Gains from Specialization and Trade
• At full production: Jones produces 10 Lager and Brown produces 4 Stout
• They trade 1 for 1: 3 Lagers for 3 Stouts • Jones now has 7L & 3S Brown has 1S & 3L
Both have more from specializing and trading
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The Gains from Specialization and Exchange
Both can now consumemore than they could
individually produce
Wealth has been increasedfor both through
specializationand trade
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Gains from specialization and exchangeProduction possibilities after specialization and tradeProduction possibilities after specialization and trade
Figure 2–1 Simple production possibilities frontiers
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Why Specialize?
• Specialization is a synonym for “following one’s comparative advantage”– Producers specialize so that they can expand
their possibilities (wealth) by trading for something that is more costly to produce on their own
– This is referred to as the “Law of Comparative Advantage”
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From Individual to International Trade, and Back Again
• Specialization and exchange occur between cities, regions and across political borders
• Each group pay for its imports with their exports
• The same idea applies at an individual level
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Transaction Costs
• Transaction costs are costs of arranging contracts and agreements – trades in general among interested parties
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Incentives to Reduce Transaction Costs: Middlemen
• Middlemen help interested parties find one another
e.g., stockbrokers, wholesalers, job placement agencies, realtors
• Middlemen’s comparative advantage is to generate quality information at a low cost
• They lower the hurdles that can impede exchange
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Markets as Discovery Processes
• To enhance wealth, people pursue their comparative advantage
• Comparative advantage is discovered through market exchanges of property rights
• In doing so, people continuously coordinate the processes of cooperative interaction that comprise the economy
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Explaining Economic Growth
• Adam Smith determined that wealth came from huge increases in production which resulted in the division of labor
• Economic growth is a consequence of the evolution of commercial society– Everyone specializes – Everyone exchanges
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Encouraging Specialization and Exchange
• Market specialization / Division of labor– creates the conditions for economic
growth• Rule of law / Private property rights
– allows freedom of exchange– provides incentives to specialize in
activities of comparative advantage
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Once Over Lightly
• exchange of property rights• a good – more preferred to less• free goods versus scarce goods• opportunity cost• wealth = whatever people value• comparative advantage
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Once Over Lightly
• Middlemen• comparative advantage• market specialization• division of labor• trade between nations