1. Lecture 4 The PPF, Comparative Advantage and International Trade
Dr. Jennifer P. Wissink
©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved.
February 6, 2017

2. Checking For The LDMR: Look At Marginal Product of Inputs
The “Law of Diminishing Marginal Returns” (LDMR): As you add more and more of a variable factor to some activity, in the presence of a fixed factor, the marginal contribution of the variable factor will eventually decline
Consider the marginal product of labor in each technology.
Marginal product of labor in making output “O” = MPLO
MPLO = (change in output O) / (change in labor)
MPLO = (ΔO) / (Δlabor)
So consider the Marginal Product of Labor in Guns and in Butter.

3. Checking For The LDMR In Guns & Butter
MPLG 2 1 3 4 5
production function for Guns
MPLG
BUTTER K L
Butter
MPLB 1 21 2 30 9 3 37 7 4 39 5 40
production function for Butter
MPLB

4. Increasing MOC Heterogeneous factors of production
The “Law of Diminishing Marginal Returns” (LDMR): As you add more and more of a variable factor to some activity, in the presence of a fixed factor, the marginal contribution of the variable factor will eventually decline.

5. The LDMR & “The Dismal Science”
Thomas Malthus & David Ricardo
English 19th century economists
Worried about fixed supply of land, LDMR, increasing population and their inability to feed themselves.
Where did they go wrong?

6. Location of the PPF & PPF Gymnastics
Suppose we have:
growth
new technology, science, innovation R&D
increases in labor productivity
increases in kapital productivity
investments in human and economic kapital
newly found/acquired resources
What happens to the PPF? B
PPF-new
PPF-old G

7. i>clicker question
Suppose Country Alpha is efficiently making both Guns and Butter. Suppose there is a technological innovation in the butter sector. Which one of the following is true?
The economy can make more guns, but not more butter as compared to before.
The economy can make more butter, but not more guns as compared to before.
The economy is inside its PPF and will move to a point on its PPF.
The economy can make more guns and more butter as compared to before.
The economy has to make more guns and more butter as compared to before. B
PPF-new
PPF-old G

8. The PPF & MOC Applied to International Trade
Very nice application of PPF.
Nice way to introduce the ideas of absolute advantage and comparative advantage.
David Ricardo, again.
Some consider him the grandfather of international trade theory.
Very influential in pioneering the theory of comparative advantage, inter alia.
Very interesting, very bright guy.
Had a lot of say about the “corn laws” in England…, and more. 8

9. The Idea Of Comparative Advantage & Trade
Specialization and free trade will benefit all trading parties, even when some are “absolutely” more efficient producers than others.
Need to understand absolute vs. comparative advantage.
Paul Samuelson on CA, “…the best example he knows of an economic principle that is undeniably true yet not obvious to intelligent people.”
Paul A. Samuelson, Economist, Dies at 94 (NYTimes obit):

10. Absolute vs. Comparative Advantage
Absolute advantage: if your country uses fewer resources to produce a given unit of output than the other country.
Comparative advantage: if your country can produce an output at a lower marginal cost in terms of other goods foregone than the other country.
Every country (or person, or economy) has a comparative advantage at some activity.
Absolute advantage is not important and may not always happen. Sometimes people or countries have the absolute advantage in nothing! Yet trade possibilities still exist.
It’s all about comparative advantage.

11. i>clicker question
Suppose this production information for England and Portugal. Assume they can make as many units of cloth and wine as they have hours of labor for. Labor can be divided in any way between cloth and wine within the country. Labor cannot move between the countries. Given the table, who has the absolute advantage in wine?
England
Portugal
Both England and Portugal
Neither
Not enough information to know
LABOR (L) HOURS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours

12. i>clicker question
Suppose this production information for England and Portugal. Assume they can make as many units of cloth and wine as they have hours of labor for. Labor can be divided in any way between cloth and wine within the country. Labor cannot move between the countries. Given the table, who has the comparative advantage in wine?
England
Portugal
Both England and Portugal
Neither
Not enough information to know
LABOR (L) HOURS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours

13. Each Country’s PPF Assume each country has L=80 hours.
LABOR HRS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours
Each Country’s PPF
Assume each country has L=80 hours.
England’s PPF
Portugal’s PPF

14. The Combined PPF W W
England’s PPF 8
Portugal’s PPF 2 40 80 C C

15. i>clicker question
Given the combined PPF, which one of the following is true?
Between points A and B on the PPF, both countries are producing both goods.
Between points B and D on the PPF, both countries are producing both goods.
At point A on the PPF only England is making wine.
At point B on the PPF England is making only cloth and Portugal is making only wine.
At point B on the PPF England and Portugal are each making 4 barrels of wine and 20 yards of cloth.
LABOR (L) HOURS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours C W 10
120 8 40 B A D

16. i>clicker question
Given the table, suppose Portugal and England are going to trade wine and cloth with each other. Suppose Portugal is making wine and England cloth. What is the lowest price (in terms of cloth) we would expect to see barrels of wine selling for?
1/10 a yard of cloth
1/20 a yard of cloth
10 yards of cloth
20 yards of cloth
10 barrels of wine
LABOR (L) HOURS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours

17. i>clicker question
Given the table, suppose Portugal and England are going to trade wine and cloth with each other. Suppose Portugal is making wine and England cloth. What is the highest price (in terms of cloth) we would expect to see barrels of wine selling for?
40 yards of cloth
1/40 a yard of cloth
10 yards of cloth
20 yards of cloth
20 barrels of wine
LABOR (L) HOURS REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel wine
40 hours
10 hours

18. Exchange Rates

19. The Combined PPF With 3 Countries!
Portugal’s PPF
France’s PPF 8
England’s PPF
The Combined PPF With 3 Countries! 3
Suppose you add France, who can make either 3 barrels of wine OR 45 yards of cloth OR anything on a straight line between these end points.
So… French MOC of cloth=1/15 bls French MOC of wine=15 yds 2 W 80 40 C 45 C C 13 C

20. An International Cloth Supply Curve

21. Note Of Caution
Information on comparative advantage is often given in many other forms - pay careful attention to the information you are given.
Three ways to present the same kind of information

22. The Beauty of the PPF