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1.0 Introduction to Economics

Economics as a Social Science •  Explain that Economics is a social science •  Outline the social scien2fic method. •  Explain the process of model building in economics. •  Explain that economists must use the ceteris paribus assump2on when developing economic models. •  Dis2nguish between posi2ve and norma2ve economics. •  Examine the assump2on of ra2onal economic decision-‐making

Scarcity •  Explain that scarcity exists because factors of produc2on are finite and wants are infinite. •  Explain that economics studies the ways in which resources are allocated to meet needs and wants. •  Explain that the three basic economic ques2ons that must be answered by any economic system are:

“What to produce?”, “How to produce?” and “For whom to produce?”

Choice and Opportunity Cost •  Explain that as a result of scarcity, choices have to be made. •  Explain that when an economic choice is made, an alterna2ve is always foregone. •  Explain that a produc2on possibili2es curve (produc2on possibili2es fron2er) model may be used to show

the concepts of scarcity, choice, opportunity cost and a situa2on of unemployed resources and inefficiency.

Central Themes •  The extent to which governments should intervene in the alloca2on of resources •  The threat to sustainability as a result of the current paMerns of resource alloca2on •  The extent to which the goal of economic efficiency may conflict with the goal of equity •  The dis2nc2on between economic growth and economic development.

Unit overview

Introduc8on to Economics Online: Scarcity Basic Economic Ques2on Opportunity cost Trade-‐offs Produc2on possibili2es curve Price Theory Circular Flow Model Factors of Produc2on Cost/Benefit Analysis Incen2ves U2lity U2lity maximiza2on Compara2ve advantage Specializa2on Economic systems Free Markets Command economies Ra2onal behavior

Introduc2on to Economics Glossary

1.0 Introduction to Economics What is Economics?

A Riddle to start off your course •  You may not know it yet, but you are beginning a science

class. Yes, Economics is a science, and just like other sciences, it deals with a fundamental problem of nature.

•  Think of Aerospace Engineering. This is a science that struggles to overcome a basic problem of nature, that of GRAVITY. Aerospace Engineers are scien2sts whose research and life’s work is aimed at overcoming the problem of gravity and puang man in space.

•  Economists are also scien2sts whose work aMempts to overcome a basic problem of nature.

Your Riddle: What is the basic problem of nature that the science

of Economic aMempts to overcome?

Hint: It arises because of the limited nature of earth’s natural resources!


Scarce (limited and desired) Not Scarce (not limited OR not desired)

Air Diamonds

Dirt

Water HIV

Computers

Doctors

Murderers Football players

Sewing machines

Nitrogen Oxygen

Love

Teachers Happiness

Clouds Bri8sh Pounds

Swiss francs

Mosquitos

factory workers

Apartments in Zurich Crea8vity

Worms

Scarcity – the Basic Economic Problem The problem that Economics, a social science, aMempts to overcome is that of Scarcity.

Scarcity arises when something is both limited in quan=ty yet desired

Some facts about scarcity •  Not all goods are scarce, but most are •  Some goods that humans consume are infinite, such as air •  Organize the following words under the correct category: Scarce or Not Scarce

Scarcity

1.0 Introduction to EconomicsWhat makes something scarce? Here’s another riddle for you… •  Nobody needs diamonds, yet they are considered extremely valuable •  Everybody needs water, yet they are considered extremely cheap

Why Are Diamonds So Expensive? Why Is Water So Cheap?

Read more: The Diamond Water Paradox

This is known as the “diamond / water paradox”. The answer lies in the fact that economic value is derived from scarcity •  The more scarce an item, the more valueable it is •  The less scarce, the less value it has in society!

Scarcity


Which of these goods are Free Goods and which are Economic Goods? Haircuts Cars Toothbrushes T.V.S Movies Happiness Shoes Vaca2ons Friendship Hamburgers Love Jewelry

Educa2on Air Fresh Water Public Transporta2on

Sunshine Etc.

Free Goods and Economics Goods Goods in Economics are those things we like to consume. They are called “goods” because consuming them makes us feel good! •  Free goods are those things that we desire but that are not limited •  Economic goods are those that we desire but that ARE limited

Economics as a Social Science: Economics is the social science that studies the interac2ons of humans in the commercial realm. Economists examine the way socie2es allocate their scarce resources towards compe=ng wants and needs and seek to develop systems that achieve certain objec2ves, including: •  Growth in humans’ standard of living over 2me •  Sustainable development •  Employment and stability

Scarcity

1.0 Introduction to Economics Do you think like an Economist?

Source: Adapted from NCEE's "AP Microeconomics" by John Morton

What do you already know about economics? Take this true/false quiz to see what you already know about Economics!

1.  -‐ 2.  -‐ 3.  -‐ 4.  -‐ 5.  -‐ 6.  -‐ 7.  -‐ 8.  -‐ 9.  -‐ 10.  -‐

T T T T T T T T T T

F F F F F F F F F F

1.  Because it is desirable, sunshine is scarce. 2.  Because it is limited, HIV is scarce. 3.  Because water covers three-‐fourths of the earth's surface it cannot be

considered scarce. 4.  The main cost of going to college is tui2on, room and board. 5.  If public transporta2on fares are raised, everyone will take the trains

anyway. 6.  You always get what you pay for. 7.  If someone makes an economic gain, someone else loses. 8.  If one na2on produces everything beMer than another na2on, there is

no economic reason for these two na2ons to trade. 9.  A non-‐regulated monopoly tends to charge the highest possible price. 10.  A business owner's decision to show more care for consumers is a

decision to accept lower levels of profits.

1.0 Introduction to EconomicsWhat do Economists study? The topics below are all some of the things you will study in your Economics course. Follow the links to see some headlines from a blog rela2ng to each of the topics

Read the following blog post: Microeconomics vs. Macroeconomics

Some key topics from your Economics Course

Scarcity Resources Trade-‐offs Opportunity cost Marginal analysis Factors of Produc2on Exchange Rates

Cost/Benefit Analysis U2lity maximiza2on Price Theory Taxes Market failure Public goods Financial markets

Environment Perfect compe22on Game Theory Price discrimina2on Income distribu2on Recession

Supply and Demand Trade Markets Prices Consumer behavior Firm behavior Free Trade

What is Economics?

1.0 Introduction to EconomicsEconomics is divided into two main fields of study Microeconomics: Studies the behaviors of INDIVIDUALS within an economy: Consumers and producers in par2cular markets. Examples of microeconomic topics: •  The Automobile market in Switzerland, •  the market for movie 2ckets in Zurich, •  the market for airline 2ckets between the US and Europe, •  the market for vaca2ons to Spain, •  the market for interna2onal school teachers.

Macroeconomics: Studies the total effect on a na2on's people of all the economic ac2vity within that na2on. The four main concerns of macroeconomics are: 1.  total output of a na2on, 2.  the average price level of a na2on, 3.  the level of employment (or unemployment) in the na2on and 4.  distribu2on of income in the na2on Examples of macroeconomic topics: •  Unemployment in Canada, infla2on in Zimbabwe, economic growth in China, the gap between the

rich and the poor in America

What is Economics?


Microeconomics examines Macroeconomics examines•  Individual markets •  the behavior of firms (companies) and consumers •  the alloca2on of land, labor and capital resources •  Supply and demand •  The efficiency of markets •  Product markets •  Supply and Demand •  Profit maximiza2on •  U2lity maximiza2on •  Compe22on •  Resource markets •  Market failure

•  Na2onal markets •  Total output and income of na2ons •  Total supply and demand of the na2on •  Taxes and government spending •  Interest rates and central banks •  Unemployment and infla2on •  Income distribu2on •  Economics growth and development •  Interna2onal trade

Microeconomics vs. Macroeconomics The two main units in your economics course can be broken down into many smaller topics. Some of them are iden2fied below.

What is Economics?

1.0 Introduction to EconomicsFundamental Concepts Weather we study micro or macro, there are some basic concepts that underly all fields of Economics study

Scarcity: Economics is about the alloca2on of scarce resources among society’s various needs and wants.

Resources: Economics is about the alloca2on of resources among society’s various needs and wants.

Tradeoffs:

Individuals and society as whole are constantly making choices involving tradeoff between alterna2ves. Whether it’s what goods to consume, what goods to produce,

how to produce them, and so on.

Opportunity Cost:

“The opportunity cost is the opportunity lost”. In other words, every economic decision involves giving up something.

NOTHING IS FREE!!

What is Economics?


Read the following from “The Worldly Philosophers” about the basic economic problems faced by all

socie2es

What is Economics?

1.0 Introduction to Economics What is Economics?

1.0 Introduction to EconomicsReading Discussion Ques2ons

1.  How is the struggle against scarcity a struggle for survival of man?

2.  Is man by nature a social creature? How does man's nature pose a challenge to his survival? Discuss...

3.  Discuss the benefits and dangers of the two ways socie2es organized economic ac2vi2es throughout most of human history a.  Tradi2on b.  command

4.  Why was there no need for "economists" throughout most of human history?

5.  "It was not at all obvious that with each man out only for his own gain, society could in fact endure. It was by no means clear that all jobs of society -‐ the dirty ones as well as the plush ones -‐ would be done if custom and command no longer ran the world. When society no longer obeyed one man's dictates, who was to say where it would end?“ Evaluate the author's claim that the economic revolu2on was "fundamentally more disturbing by far than the French, the American, or even the Russian Revolu2on."

What is Economics?

1.0 Introduction to EconomicsThe Factors of Produc2on The produc2on of all of the good we desire requires scarce resources. It is the alloca2on of these resources between humans’ compe2ng wants that Economics focuses on.

The productive Resources

Land Labor Capital Entrepreneurship

Land resources are those things that are "gius of nature". The soil in which we grow food, wood,

minerals such as copper and 2n and resources

such as oil, goal, gas and uranium are scarce

Labor refers to the human resources used in the produc2on of goods and services. Labor is the

human work, both physical and intellectual, that contributes to the produc2on of goods and

services

Capital refers to the tools and technologies that are

used to produce the goods and services we desire. Since more and beMer tools enhance the produc2on of all types of goods and services, from cars to computers to educa2on to haircuts,

yet the amount of capital in the world is limited, capital is a scarce

resource.

This refers to the innova2on and crea2vity applied in the produc2on of goods and services. The physical scarcity of land, labor and capital

does not apply to human ingenuity, which itself is a resource that goes into the produc2on of out economic output.

1.0 Introduction to EconomicsThe Basic “Economic Problem”? In a world of finite resources, the wants of man are virtually infinite. The basic Economic Problem is how to allocate those limited, scarce resources between the unlimited wants of man. This problem gives rise to three ques2ons that any and all economic systems must address. The Three Basic Econoimcs Ques2ons are :

1.  What should be produced? Given the resources with which society is endowed, what combina2on of different goods and services should be produced?

2.  How should things be produced? Should produc2on use lots of labor, or should lots of capital and technology be used?

3.  Who should things be produced for? How should the output that society produces be distributed? Should everyone keep what he or she makes, or should trade take place? Should everyone be given equal amounts of the output, or should it be every man for himself?

These are the three guiding ques=ons of any Economic system

The Basic Economic Questions


Adam Smith on Trade: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address

ourselves, not to their humanity but to their self-‐love, and never talk to them of our necessi=es but of their advantages" -‐ Adam Smith "The Wealth of Na=ons"

Introduction to Trade

Free Trade The market system allocates society’s scarce resources through the free, voluntary exchanges of individuals households and firms in the free market. These exchanges are broadly known as “trade”. Trade ban exist between individuals, or between en2re na2ons. Trade between countries is called Interna8onal Trade.

Trade is one of the concepts fundamental to the field of economics. Voluntary exchanges between individuals and firms in resource and product markets involving the exchange

of goods, services, land, labor and capital is a type of trade.

Interna2onal trade involves the exchange of resources, goods, services, assets (both real and financial) across na2onal boundaries.

Trade makes everyone beMer off, and leads to a more efficient alloca2on of society's scarce resources.


Adam Smith on the mutual benefits of trade: "Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of."

And on self-‐interest: "Every man…is first and principally recommended to his own care; and every man is certainly, in every respect, fiPer and abler to take care of himself than of any other person."

Adam Smith, the father of Modern Economics •  Lived 1723-‐1790 •  Leading thinker of the Scoash Enlightenment •  Two great works: The Theory of Moral Sen=ments (1759) and The

Wealth of Na=ons (1776) Believed that humans ac2ng in their own self-‐interest would lead to benefits for society as a whole, since the pursuit of self-‐interest naturally leads individuals to meet the wants and needs of those around them.

Introduction to Trade

1.0 Introduction to EconomicsModel Building in Economics A popular tool in the Economist’s kit is the economic model. Just like scien2sts in other fields, economists use models to represent something from the real world.

A model of the solar system: Allows astronomers to illustrate in a simplified model the rela2onships between solar bodies.

A Circular Flow Model: Allows economists to illustrate in a simplified model the rela2onships between households and firms in a market economy. Ceteris Paribus: Like in other scien2sts, when using economic models we must assume “all else equal”. This allows us to observe how one variable in an economy will affect another, without considering all the other factors that may affect the variable in ques2on.

1.0 Introduction to EconomicsPosi2ve and Norma2ve Economics Economists explore the world of facts and data, but also ouen draw conclusions or prescribe policies based more on interpreta2on or even their own opinions. It is important to dis2nguish at all 2mes whether the focus of our studies is in the realm of posi=ve or norma=ve Economics

Norma2ve economic statements: Each of the statements above are based on observable, quan2fiable variables, but each includes an element of opinion •  Unemployment rates are higher among less educated workers, therefore government should include educa=on and job

training programs as a component of benefits for the na=on's unemployed. •  Rising pork prices harm low income households whose incomes go primarily towards food, therefore, to slow the rise in

food prices, the Chinese government should enforce a maximum price scheme on the na=on's pork industry. •  It is the government's obliga=on to provide public transporta=on op=ons to the na=on's people to relieve the nega=ve

environmental and health effects of traffic conges=on.

Posi2ve economic statements: Each of the following statements above are statements of fact, and each can be supported by evidence based on quan2fiable observa2ons of the world. •  Unemployment rose by 0.8 percent last quarter as 250,000 Americans lost their jobs in both the public and private

sectors. •  Rising pork prices have led to a surge in demand for chicken across China. •  Increased use of public transporta=on reduces conges=on on city streets and lowers traffic fatality rates.

1.0 Introduction to Economics Opportunity Cost

Examples of opportunity costs •  The opportunity cost of watching TV on a weeknight is the benefit you could have goMen

from studying. •  The opportunity cost of going to college is the income you could have earned by geang a job

out of high school •  The opportunity cost of star2ng your own business in the wages you give up by working for

another company •  The opportunity cost of using forest resources to build houses is the enjoyment people get

from having pris2ne forests.

Opportunity Cost Perhaps the most fundamental concept to Economics, opportunity cost is what must be given up in order to undertake any ac2vity or economic exchange. •  Opportunity costs are not necessarily monetary, rather when you buy something, the opportunity

cost is what you could have done with the money you spent on that thing. •  Even non-‐monetary exchanges involve opportunity costs, as you may have done something different

with the 2me you chose to spend undertaking any ac2vity in your life.

1.0 Introduction to EconomicsOpportunity Cost in the Produc2on Possibili2es Model The tradeoff we face between the use of our scarce resources (or even 2me) can be modeled in a simple Economic graph known as the Produc2on Possibili2es Curve (the PPC). Study the graph below:

Tradeoffs in the PPC: Sarah faces two tradeoff. She can either work or play with her limited amount of 2me. •  The opportunity cost of an hour of work is an

hour of play •  As she goes from 3 hours of work to 7 hours of

work, she gives up 4 hours of play. •  She cannot spend 10 hours working AND 10

hours playing, so Sarah has to make CHOICES

This basic model can be used to illustrate the economic challenges faced by individuals, firms,

states, countries or the en=re world…

The PPC

1.0 Introduction to EconomicsConsider the hypothe2cal PPC for the country of Italy This model shows that Italy can produce: •  Either 7.5 million pizzas, •  OR 750 robots •  Note, however, that Italy can NOT produce 7.5 million

pizzas AND 750 robots Italy faces a tradeoff in how to use its scarce resources of land, labor and capital. As the country moves along its PPC from point A to point D: •  It gives up more and more pizza to have more robots •  It gives up current consump=on of food for produc=on

of robots, which themselves are capital goods, and therefore will assure that Italy’s economy will grow into the future.

The PPC


Observa8ons about points on or within the PPC •  Points ON the PPC are aMainable, and desirable, since a

country producing on the line is achieving full employment and efficiency

•  Points inside the PPC (such as E) are aMainable but undesirable, because a na2on producing here has unemployment and is inefficient

•  Points outside the PPC (such as F) are unaMainable because they are beyond what is presently possibble given the country’s scarce resources. But such points are desirable because they mean more output and consump2on of both goods.

Assump2ons about the PPC •  A point ON the PPC is aMainable only if a na2on achieves

full-‐employment of its produc2ve resources •  The na2on's resources are fixed in quan2ty •  The economy is closed, i.e. does not trade with other

countries •  Represents only one country's economy

The PPC

1.0 Introduction to EconomicsStraight –line versus curved PPCs A PPC can be either straight (A) or bowed outwards from the origin (B). A straight line PPC •  Indicates that the two goods require similar resources to produce

(like pizzas and calzones) •  The opportunity cost of one pizza is one calzone, so Italy always gives

up the same quan2ty of one good no mater where it is on its PPC

A bowed out PPC •  Indicates that the two goods require very different resources to

produce (like pizzas and robots) •  As Italy increases its output of one good, the oportunity cost (in

terms of the quan2ty of the other good that must be given up) increases.

(A)

(B) The Law of Increasing Opportunity Cost:

As the output of one good increases, the opportunity cost in terms of other goods tends to increase

The PPC

1.0 Introduction to EconomicsKey Concepts shown by the PPC In addi2on to opportunity costs and tradeoffs, the PPC can be used to illustrate several other key Economic concepts, including…

•  Scarcity: Because of scarcity, society can only have a certain amount of output

•  Actual output: A country’s actual output is shown by where it is currently producing on or within its PPC

•  Poten8al output: A point on the PPC shows the poten2al output of a na2on at a par2cular 2me

•  Economic growth: An increase in the quan2ty or the quality of a na2on’s resources will shiu its PPC out, indica2ng the economy has grown

•  Economic development: The composi2on of a na2on’s output will help determine whether the standards of living of its people are improving over 2me

The PPC

1.0 Introduction to Economics Economic Growth vs. Economic Development

Economic Growth vs. Economic Development Two of the key areas of study in economics are those of growth and development. Some2mes these concepts are thought of as the same, but they are not.

Economic Growth: This refers to the increase in the total output of goods and services by a na2on over 2me. •  It is also some2mes defined as an increase in household income over

2me. •  It is purely a monetary measure of the increases in the material well

being of a na2on. •  On a PPC growth can be shown as an outward shiu of the curve. Economic Development: This refers to the improvement in peoples’ standard of living over 2me. •  Measured by improvements in health, educa2on, equality, life

expectancy and so on •  Incorporate income as well, but is a much broader measure than growth •  On a PPC development can be shown by a movement towards the

produc2on of goods that improve peoples’ lives

1.0 Introduction to Economics PPC Video Lesson

SCARCITY, OPPORTUNITY COST AND THE PRODUCTION POSSIBILITIES CURVE

1.0 Introduction to Economics PPC Video Lesson

THE LAW OF INCREASING OPPORTUNITY COST AND THE PPC MODEL

1.0 Introduction to Economics Opportunity Cost

Announcement: All economics students will receive a FREE LUNCH of pizza and soda compliments of

your Economics teacher this Friday!

1.0 Introduction to Economics"There's No Such Thing As A Free Lunch!” It is a popular saying among Economists that there is no such thing as a free lunch: •  Everything in life has a cost associated with it. •  The free lunch your teacher offers you is not really free.

There are opportunity costs associated with giving up your lunch break to eat with your teacher

If nothing in life is free, then why do we seem to be surrounded by things that are FREE? Analyze each of the signs below and determine whether you’re really gehng anything for free.

Opportunity Cost

1.0 Introduction to Economics Markets

Product and Resource Markets In the market system, there exists an interdependence between all individuals. •  Households (that’s us) depend on the goods and services produced by business firms, and

the incomes they provide us, for our survival •  Business firms depend on households for the workers, the capital, the land resources they

need to produce the goods they hope to sell us and make profits on.

Product Markets Resource Markets

Where households buy the goods and services we desire from firms. Examples: •  The market for private schools •  The market for dental services •  The market for airline travel •  The market for football merchandise

Where business firms buy the produc2ve resources they need to make their products: •  The market for teachers •  The market for den2sts •  The market for pilots •  The market for football players

These exchanges all take place in one of two categories of market present in all market economies


In Product Markets: •  Consumers buy goods and services from firms •  Households use their money incomes earned in the resource market to buy goods and services •  Expenditures by households become revenues for firms •  Firms seek to maximize their profits •  Households seek to maximize their u8lity (happiness)

In Resource Markets: •  Households supply produc2ve resources (land, labor, capital) •  Firms buy produc2ve resources from households. In exchange for their produc2ve resource, firms

pay households: Ø  Wages: payment for labor Ø  Rent: payment for land Ø  Interest: payment for capital Ø  Profit: payment for entrepreneurship

•  Firms seek to minimize their costs in the resource market •  Firms employ produc2ve resources to make products, which they sell back to households in the

product market

No=ce the circular flow of money payments from one market to the other

Markets

1.0 Introduction to EconomicsThe Circular Flow

of Resources

The Circular Flow Market economies are characterized by a circular flow of money, resources, and products between households and firms in resource and product markets. No2ce: •  Money earned by

households in the resource market is spent on goods and services in the product market

•  Money earned by firms in the product market is spent on resources from households in the resource market.

The incen8ves of Households: Maximize UFlity The incen8ve of Firms: Maximize Profits!


For Land: Rent Firms pay households RENT. Landowners have the op2on to use their land for their own use or to rent it to firms for their use. If the landowner uses his land for his own use, the opportunity cost

of doing so is the rent she could have earned by providing it to a firm.

For Labor: Wages Firms pay households WAGES. To employ workers, firms must pay workers money wages. If a worker is self employed, the opportunity cost of self-‐employment is the wages he could have

earned working for another firm.

For Capital: Interest

Firms pay households INTEREST. Most firms will take out loans to acquire capital equipment. The money they borrow comes mostly from households' savings. Households put their money in

banks because they earn interest on it. Banks pay interest on loans, which becomes the payment to households. If a household chooses to spend its extra income rather than save it, the

opportunity cost of doing so is the interest it could earn in a bank.

Entrepreneurship: Profits

Households earn PROFIT for their entrepreneurial skills. An entrepreneur who takes a risk by puang his crea2ve skills to the test in the market expects to earn a normal profit for his efforts.

Resources

Resource Payments (Incomes for households) In exchange for their land, labor, capital and entrepreneurship, households receive payments. The payments for the four produc2ve resources (which are costs for firms) ar…

1.0 Introduction to Economics Circular Flow Model Video Lesson

THE CIRCULAR FLOW MODEL OF A MARKET ECONOMY


Examples of how prices allocate resources: Imagine a city with two types of street food, hot dogs and kebabs. How would price assure that the right amount of these two foods is produced based on consumer demand. At present, •  The price of a hot dog is $2 •  The price of a kebab is $3 Due to a report on the nega2ve effects of hot dogs on health, consumers now demand more kebabs. How will each of the two systems assure that the increased demand for kebabs is met?

The Price Mechanism Prices are how resources are allocated between compe2ng interests in a market economy. Without tradi2on or command determining the alloca2on of resources, prices send the signals to producers and consumers regarding what should be produced, how it should be produced, and for whom.

The Price Mechanism

Prices are signals from buyers to sellers! As the demand for kebabs rises, they will become more scarce, causing the price to rise. Sellers will realize there are more profits in kebabs and hot dog vendors will switch to kebabs.

The price mechanism led to a realloca=on of resources!


If only they'd make more brown leather handbags!

Price of brown bags rises, other colors must get cheaper to sell

More brown bags are made available to buyers

Wow, we keep selling out of brown bags, let's raise the price!

Yeah, and we better lower the price of black bags!

Prices as the Alloca2ng mechanism in the market economy

The Price Mechanism


Commanding Heights -‐ 1.3 & 1.4 Vienna and the Soviet Union

The Price Mechanism Video

1.0 Introduction to EconomicsIntroduc2on to Interna2onal Trade The expansion of voluntary trade between na2ons has been a defining characteris2c of the global economic system since the second World War. But peoples’ view on trade were not always so liberal. US President Lincoln once argued that… To me that if we buy the rails from England, then we've got the rails and they've got the money. But if we

build the rails here, we've got our rails and we've got our money." Author and poli2cal Economist Charles Wheelan paraphrased Lincoln’s view of trade in the following way:

"If I buy meat from the butcher, then I get the meat and he gets my money. But if I raise a cow in my backyard for three years and slaughter it myself, then I've got the meat and I've got my money.“

What’s wrong with Lincoln’s logic? Lincould probably would not argue against a family buying their meet from a butcher. What he does not recognize is that what makes an economy thrive at the level of individual consumers can also help an economy thrive at the interna2onal level. b

International Trade

Key Ques8ons about Interna8onal Trade

Why do na2ons trade? What are the gains from trade between na2ons?

How does a na2on determine what it should produce? What are the obstacles to free trade?

1.0 Introduction to Economics International Trade

Specializa2on based on Compara2ve Advantage Because the world’s produc2ve resources are not distributed evenly between na2ons, it does not make sense that every na2on tries to produce the same goods. Rather, na2ons tend to specialize in goods for which their natural, human and capital resources are par2cularly appropriate to produce. These may be…

What does your country specialize in the produc=on of? Why?

Labor-intensive goods Land-intensive goods

Examples: Tex2les

Low-‐skilled manufactured goods

Where? China

La2n America Low-‐wage countries

Examples: Agricultural products

Minerals Timber resources

Where? North America

Russia Australia

Capital-intensive goodsExamples: Airplanes

Automobiles Microchips

Where? Western Europe

Japan South Korea


Specializa2on based on Compara2ve Advantage What a par2cular na2on should produce and trade is based on what the country has a compara2ve advantage in the produc2on of. •  Compara8ve Advantage: A country has a compara2ve advantage in produc2on of a certain product

when it can produce that product at a lower rela2ve opportunity cost than another country. Produc8on Possibili8es Analysis: Consider two countries, South Korea and the United States.

How much do apples "cost“ each country to produce? •  The US can produce either 39 apples or 13

cell phones.•  1 apple = 1/3 cell phone•  S. Korea can produce either 24 apples or 12

cell phones.•  1 apple = ½ cell phoneHow much do cell phones “cost”?•  The US must give up 3 apples for each cell

phone it produces.•  S. Korea must give up only 2 apples for

each cell phone it produces.

apples

cell phones

apples

cell phones

39

13

24

12

PPC -‐ USA PPC -‐ Korea

The US has a compara=ve advantage in apples, South Korea in cell phones


apples

cell phones

apples

cell phones

39

13

24

12

36

19.5

Trading possibili8es line USA

Trading possibili8es line Korea

Specializa2on based on Compara2ve Advantage Because the US has a lower opportunity cost for apples than S. Korea, and S. Korea has a lower opportunity cost for cell phones than the US, these two countries can benefit from specializing and trading with one another. •  United States: Specialize in apples -‐> trade

apples for cell phones with Korea. Korea should be willing to trade 1 apple for anything up to, but not beyond, 1/2 cell phone. Before trade, 1 apple could only be get America 1/3 cell phone.

•  The US has gained from trade. •  South Korea: Specialize in cell phones -‐>

trade cell phones for apples with the US. The US should be willing to exchange up to three apples for one cell phone. Before trade, Korea could only get two apples for each cell phone it gave up.

•  South Korea has gained from trade.

The red dashed lines represent the maximum amount of output the two countries could hope to consume as a result of trade with one another. This is the trading possibili=es line. Trade allows each na=on to consumer beyond its own produc=on possibili=es.


Specializa2on based on Compara2ve Advantage Specializa2on is defined as “the use of the resources of an individual, a firm, a region, or a naFon to concentrate produc=on on one or a small number of goods and services.“ •  What a person, company or country should specialize in depends on the task for which it has the lowest

opportunity costs. •  Countries should specialize based on the products for which they have a compara2ve advantage Terms of trade: Terms that are mutually beneficial to the two countries in trade. Where the trade leaves both countries beMer off than they were originally. Gains from Specializa2on and Trade: Specializa2on based on compara2ve advantage improves global resource alloca2on. Each country would result in a larger global output with the same total inputs or world resources and technology.

Specializa=on and trade based on compara=ve advantage increases the produc=vity of a na=on's resources and allows for greater total output

than would otherwise be possible.


Mexico

USA

Soybeans Avocados

60 15

30 90

Reading the table: Given a fixed amount of resources, Mexico and the USA can choose between the following alterna2ves.

Output Table Input Table Reading the table: In order to produce one ton of output, Mexico and the USA must use the following amount of resources. (in acres of land)

Mexico

USA

Soybeans Avocados

8 16

8 6

Specializa2on and Trade based on Produc2on Possibili2es Tables The PPC provides a graphical means of displaying a na2on’s poten2al output of two goods. The same informa2on can be shown in a table as well. These tables come in two types, Output and Input tables.

How to determine specializa8on and trade based on a table 1.  Iden2fy the opportunity costs of soybeans and avocados in Mexico and the USA 2.  The countries should specialize in the one for which they have the lower opportunity cost. 3.  Cross mul2plica2on trick. (maximize output and minimize inputs)


Mexico

USA

Soybeans Avocados

60 15

30 90

Output Problem

X

= 1800

= 1350

Input Problem

Mexico

USA

Soybeans Avocados

8 16

8 6

X = 64

= 96

For an output problem, simply cross mul2ply and then choose the highest level of output.

For an input problem, cross-‐mul2ply and then choose the combina2on that uses the least amount of

inputs.

Output is maximized when the US specializes in soybeans and Mexico in avocados.

Inputs are minimized when the US specializes in soybeans and Mexico in avocados.

Specializa2on and Trade based on Produc2on Possibili2es Tables Based on the tables below, Mexico has the compara2ve advantage in avocados and the US in soy beans. The two countries should specialize and trade with one another based on these advantages.


Mexico

USA

Soybeans Avocados

60 15

30 90 Soybeans

Avocados

30

15

60 90

USA

Mexico

Absolute Advantage versus Compara2ve Advantage Having put the data into a PPC, it is clear that the US is, in fact, beMer at produc2ng BOTH avocados and soybeans. The US has an absolute advantage in both goods •  Absolute Advantage: When a na2on can produce a certain good more efficiently than another na2on. •  How is this different from compara8ve advantage? Having an absolute advantage in a product, as the

US does in both soybeans and avocadoes, does not mean a country has a lower opportunity costs in both products. The US should s2ll only specialize in what it has a compara=ve advantage in.

Soybeans Avocados

In US: 1s = 3a In US: 1a=1/3s

In Mexico: 1s=4a In Mexico: 1a=1/4s


DETERMINING COMPARATIVE ADVANTAGE USING PPCS – WORKED SOLUTIONS TO AP FREE RESPONSE QUESTIONS

International Trade Video Lesson

1.0 Introduction to EconomicsOther Key Themes in Economics Having introduces several of the topics you will study in this course, we can now look at some of the major themes that will underlie all sec2ons of the course. These include: •  The role of government in the economy: In every unit of this course we will examine the appropriate

role of government in the market economy. There are some who argument government should never interfere with the free func2oning of markets; on the other hand, when market failures arise, the government may be needed to improve the alloca2on of resources.

•  Threats to sustainability of current economic trends: What threat do global warming, environmental degreda2on, popula2on growth and urbaniza2on play to the ability of our economic systems to endure?

•  The conflict between the pursuits of efficiency and equity: Some2mes the pursuit of wealth and economic growth leaves some individuals behind. To what extent should economic policy be concerned with income and wealth inequality? Is there a mechanism available for reducing inequality while at the same 2me encouraging efficiency?

•  The dis8nc8on between economic growth and economic development: The emerging market economies of the world have achieve amazing economic growth for decades; but at what cost? Is increasing income and output the only thing the market system is good for? Does geang richer assure we will be happier, live longer and healthier lives, and live in a just society?

Each of these themes will guide us in our examina=on of Economics throughout the course

Central Themes in Economics

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