Econ 206(A) Tutorial 1 - Examples

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Presentation transcript:

Econ 206(A) Tutorial 1 - Examples Colin Green

Opportunity Cost - Example What does it cost to go to University? Direct Costs: Tuition Fees + Living Expenses etc Opportunity Cost? Lost Earnings (for instance £15K a year for 3 years)

Absolute and Comparative Advantage – Example 2 Countries: Portugal and England 2 Products: Wine and Cloth Portugal can produce 100 wine or 50 cloth (or a mixture) England can produce 20 wine or 40 cloth (or a mixture)

Mixture (pre trade) Cloth Wine Portugal 25 50 England 20 10 Total 40 100

Absolute Advantage 2 Questions: Which Country has absolute advantage in cloth production? Which Country has absolute advantage in wine production? Portugal: It can produce more of both

Opportunity Cost What is the opportunity cost of cloth production in both countries? Portugal = 2 units of Wine England = ½ unit of Wine What is the opportunity cost of wine production in both countries? Portugal = 1/2 unit of Cloth England = 2 units of Cloth

Portugal 50 or 100 2 wine England 40 or 20 ½ Wine Cloth Wine Opportunity Cost of producing 1 cloth Portugal 50 or 100 2 wine England 40 or 20 ½ Wine

Comparative Advantage 1. Which country has comparative advantage in cloth production? England as its opportunity cost of cloth production is lower. 2. Which country has comparative advantage in wine production? Portugal as its opportunity cost of wine production is lower. Optimal for each country to specialise and then trade with each other.

Specialisation Cloth Wine Portugal 100 England 40 Total

Trade It pays to specialise because of trade. Assume some simple prices: For example: England requires at least 1/2 unit of wine for 1 unit of cloth. Portugal needs at least 1/2 unit of cloth for 1 unit of wine. If we take some middle price (1 units of cloth per unit of wine). Then both countries can be better off through specialisation and trade.

Post Trade Portugal 20 80 England Total 40 100 Cloth Wine Assume Portugal trades 20 wine for 20 cloth. Both can consume a combination of cloth and wine that was not possible pre-trade

Cloth Wine Portugal 10 80 England 20 Total 100 Pre Trade Comparison (If Portugal & England produced the same amount of wine as their post trade amount) Cloth Wine Portugal 10 80 England 20 Total 100

Comparative Advantage (2) Specialisation in Labour An individual is the best lawyer and the best secretary in town. (i.e. has absolute advantage in being a Lawyer and a Secretary) What should they do?