Economics 2010 Rober Martinez-Espineira Lecture 4 Growth and Trade

Growth and Trade QUIZ1 WEEK 5 (Fri OCT 14th)

Growth and Trade Economic growth Gains from trade The evolution of trading arrangements

Economic Growth economic growth = expansion of production possibilities Why do production possibilities expand?

Economic Growth The two key factors that influence economic growth are: technological progress capital accumulation

Determinants of Economic Growth Technological progress (development of new and better ways to produce goods and services and development of new goods) Capital accumulation growth of capital resources

Economic Growth Economic growth in a factory Install more capital or adopt new technology

Economic Growth Economic growth in a household Invest in human capital (or other types of capital: buy a washing machine!)

Economic Growth Economic growth in a nation Invest in new technologies, and capital, including human capital,

Gains from trade Everyone gains from trade Trade is not a zero-sum game The source of gain is comparative advantage A person has a comparative advantage in producing a particular good if that person can produce the good at a lower opportunity cost than anyone else

Gains from trade Mark can produce jeans or skirts For Mark, 1 skirt costs 0.5 jeans Or, 1 pair of jeans costs 2 skirts

Gains from trade Marjorie can produce jeans or skirts For Marjorie, 1 skirt costs 0.08 jeans Or, 1 pair of jeans costs 12.5 skirts

Gains from trade Let’s look at these two PPFs on a single picture Suppose each produces the same quantities

Gains from trade How can they gain from trade? By specializing in the activity at which they have a comparative advantage

Gains from trade They can now exchange (trade) jeans and skirts. Suppose Marjorie sells Mark 12.5 thousand skirts for 2.5 thousand jeans

Gains from trade Mark now gets skirts at a cost of 0.2 pairs of jeans per skirt His opportunity cost of producing skirts is 0.5 pairs of jeans per skirt

Gains from trade Marjorie now gets jeans at a cost of 5 skirts per pair of jeans Her own opportunity cost of producing jeans is 12.5 skirts per pair of jeans

Gains from trade They each can operate outside their individual production possibilities frontiers

Evolution of trading arrangements Note that, just as in the example you have in your book These gains form a trade apply also when one of the traders has an absolute advantage in the production of both goods relative to the other person! 

Gains from Trade: one person has the absolute advantage at making both goods Liz's Smoothie Bar In an hour, Liz can produce 40 smoothies or 40 salads. Liz's opportunity cost of producing 1 smoothie is 1 salad. Liz's opportunity cost of producing 1 salad is 1 smoothie. Liz’s customers buy salads and smoothies in equal number, so she produces 20 smoothies and 20 salads an hour.

Gains from Trade Joe's Smoothie Bar In an hour, Joe can produce 6 smoothies or 30 salads. Joe's opportunity cost of producing 1 smoothie is 5 salads. Joe's opportunity cost of producing 1 salad is 1/5 smoothie. Joe spends 10 minutes making salads and 50 minutes making smoothies, so he produces 5 smoothies and 5 salads an hour.

Gains from Trade Liz’s Absolute Advantage Absolute advantage When one person is more productive than another person in several or even all activities. Liz is four times as productive as Joe—Liz can produce 20 smoothies and 20 salads an hour and Joe can produce only 5 smoothies and 5 salads an hour.

Gains from Trade Liz’s Comparative Advantage Liz’s opportunity cost of a smoothie is 1 salad. Joe’s opportunity cost of a smoothie is 5 salads. Liz’s opportunity cost of a smoothie is less than Joe’s, so Liz has a comparative advantage in producing smoothies.

Gains from Trade Joe’s Comparative Advantage Joe’s opportunity cost of a salad is 1/5 smoothie. Liz’s opportunity cost of a salad is 1 smoothie. Joe’s opportunity cost of a salad is less than Liz’s, so Joe has a comparative advantage in producing salads.

Gains from Trade Achieving Gains from Trade Liz and Joe produce more of the good in which they have a comparative advantage: Liz produces 35 smoothies and 5 salads. Joe produces 30 salads.

Gains from Trade Liz and Joe trade: After trade: Liz sells Joe 10 smoothies and buys 20 salads. Joe sells Liz 20 salads and buys 10 smoothies. After trade: Liz has 25 smoothies and 10 salads. Joe has 25 smoothies and 10 salads.

Gains from Trade Gains from trade: Liz gains 5 smoothies and 5 salads an hour—she originally produced 20 smoothies and 20 salads. Joe gains 5 smoothies and 5 salads an hour—he originally produced 5 smoothies and 5 salads.

The Economics of Campus Life 102 The Economics of Campus Life 102. Now ask the students whether they find the second hour of study as productive as the first and the third as productive as the second, and so on. With a bit of help, they will tell you that the effect on the GPA of an extra hour a day of study gets smaller the more hours per day the student studies. Now give them the table on this hidden slide, which is similar to that in Figure 2.1and that captures this observation. Ask the students to use the data in the table to draw the PPF graph and to calculate the opportunity cost of each successive hour recreation. Note that the opportunity cost of recreation is now increasing. Ask them if this case looks more “realistic.” To unhide this slide and add it to your lecture, select Slide Show on the menu bar and then click Hide Slide to cancel the hide.

Gains From Trade Figure 2.7 shows the gains from trade. Joe initially produces at point A on his PPF. Liz initially produces at point A on her PPF.

Gains From Trade Joe’s opportunity cost of producing a salad is less than Liz’s. So Joe has a comparative advantage in producing salad.

Gains From Trade Liz’s opportunity cost of producing a smoothie is less than Joe’s. So Liz has a comparative advantage in producing smoothies.

Gains From Trade If Joe specializes in producing salad, he produces 30 salads an hour at point B on his PPF.

Gains From Trade If Liz produces 25 smoothies and 5 salad an hour, she produces at point B on her PPF.

Gains From Trade They exchange salads for smoothies along the red “Trade line.” The price of a salad is 2 smoothies or the price of a smoothie is ½ of a salad.

Gains From Trade Joe buys smoothies from Liz and moves to point C—a point outside his PPF. Liz buys salads from Joe and moves to point C—a point outside her PPF.

Gains From Trade Dynamic Comparative Advantage Learning-by-doing occurs when a person (or nation) specializes and by repeatedly producing a particular good or service becomes more productive in that activity and lowers its opportunity cost of producing that good over time. Dynamic comparative advantage occurs when a person (or nation) gains a comparative advantage from learning-by-doing.

Evolution of trading arrangements Trade between nations is similar to trade between Mark and Marjorie Trade among millions of people has evolved social mechanisms and institutions to facilitate that trade markets property rights money

Property rights are social arrangements that regulate the ownership, use and disposal of resources. A market is any institution that enables buyers and sellers to get information and trade with each other. They help co-ordinate individual decisions through price adjustments.

Key terms opportunity cost absolute advantage comparative advantage specialization trade property rights market

Next Any questions about today’s stuff? Demand and Supply Read Parkin’s Chapters 3 and 4!!!