Specialization and Exchange

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Specialization and Exchange
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Opportunity cost in PPF

• The opportunity cost of going from one point to
  another on a PPF is the slope of the line that
  connects the two points
• A constant slope of a PPF implies constant
  opportunity costs

PPF
y1
y2
x1
x2
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Opportunity cost in PPF

• A changing slope implies changing (non constant)
  opportunity cost

Guns
A
y1
C
B
y2
Butter
x1
x2
4
A
B
C
D
E
W
F
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Increasing Opportunity Cost

• According to law of increasing opportunity cost
• The more of something we produce, the greater the
  opportunity cost of producing even more of it
• This principle applies to all of societys
  production choices
• Why?
• All resources are not equally efficient or
  suitable for producing all outputs.

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Efficiency and Inefficiency

• Productive efficiency achieving as much output
  as possible from a given amount of resources
  occurs at any point on the PPC.
• Any point within the PPC represents inefficiency.
• Any point outside the PPC is unattainable, given
  present resources and technology.

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Efficiency and Inefficiency
10
8
6
Guns

4
2
0
2 4 6
8
10

Butter
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Summary of PPF

• So far, we learn that PPFs show us
• Productive capabilities given available resources
  and technology.
• Efficiency
• Inefficiency
• Scarcity
• Choice
• Opportunity Cost

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Recessions

• A slowdown in overall economic activity when
  resources are idle
• Widespread unemployment
• Factories shut down
• Land and capital are not being used
• An end to the recession would move the economy
  from a point inside its PPF to a point on its PPF
• Using idle resources to produce more goods and
  services without sacrificing anything
• Can help us understand an otherwise confusing
  episode in U.S. economic history

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Figure 2 Production and Unemployment
B
A
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Economic Growth

• If economy is already operating on its PPF
• Cannot exploit opportunity to have more of
  everything by moving to it
• But what if the PPF itself were to change?
  Couldnt we then produce more of everything?
• This happens when an economys productive
  capacity grows
• Many factors contribute to economic growth, but
  they can be divided into two categories
• Quantities of available resources.
• Technological change

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Shifts in the PPC
Neutral Technological Change
Biased Technological Change
Butter

C
Butter
C
B

A
0
0
D
B
A
Guns
Guns
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• Blue Sheet exercises

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Discussion Can we separate from economic
system?

• How did it come about that you, who did not
  produce any of these things yourself, are able to
  consume them?

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History and perspective

• Westward expansion of U.S.
• First settler
• - Self-sufficient
• More people arrive
• - Specialize
• - Trade
• - Division of labor
• Gains from trade enhance production.

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Exchange and appearance of Money

• Suppose the farmer need to see a doctor. How did
  he pay?
• - Bartering direct exchange of goods/services
• Mutual coincidence of Wants
• - I must want what you have, and you must have
  what I want.
• Money
• Medium of exchange
• Generally accepted
• Purchasing power

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Specialization and Exchange

• Specialization
• Method of production in which each person
  concentrates on a limited number of activities
• Exchange
• Practice of trading with others to obtain what we
  want
• Allows for
• Greater production
• Higher living standards than otherwise possible
• All economics exhibit high degrees of
  specialization and exchange

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Further Gains to Specialization

• Absolute Advantage
• Ability to produce a good or service using fewer
  resources than other producers use
• Comparative Advantage
• If one can produce some good with a smaller
  opportunity cost than others can
• Total production of every good or service will be
  greatest when individuals specialize according to
  their comparative advantage
• Another reason why specialization and exchange
  lead to higher living standards than
  self-sufficiency

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Law of comparative advantage

• We can gain by producing goods for which we have
  the lowest opportunity costs (comparative
  advantage) and then trading.

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Example 2.5 shipwreck survivors

• Imagine that after a shipwreck, Robinson Crusoe
  wash up on shores of a deserted island. Where
  later he found his servant Friday

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PPFs and Trade

• Specialization and Trade
• Comparative and Absolute Advantage
• When PPFs are Linear
• When PPFs are Curved
• Robinson Crusoe (pages 19-20 in packet)

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Determining comparative advantage by just looking
at graph

• Slope of PPF indicates opportunity cost
• Whoever has flattest slope with respect to X axis
  has lowest opportunity cost of producing X

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• Crusoe Opp. Cost
• To move from f to e
• As bread rises by 6, cloth falls by 1
• 6 B 1 C
• B 1/6 C

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• 1/6 yard
• cloth

6 loaves Bread
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Robinson Opp. Costs

• e to d
• 5 B 1 C
• B 1/5C
• d to c
• 4 B 1 C
• B ¼ C
• c to b
• 3 B 1 C
• B 1/3 C

• b to a
• 2 B 1 C
• B ½ C

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• 1/6 yard
• cloth

6 loaves Bread
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Friday Opp. Costs

• a1 to b1
• 1 B 2 C
• 1/2 B 1 C
• b1 to c1
• 1 B 2 C
• ½ B 1 C

• c1 to d1
• 1 B 2 C
• ½ B 1 C
• d1 to e1
• 5B 3 C
• 1 B 3/5 C
• 5/3 B 1 C

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Robinson has lower opportunity cost for bread
production.
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Friday has lowest opp. Cost for cloth production.
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If they specialize

• h) 20 loaves bread and 9 yards cloth

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Total output without specialization
Robinsons PPF
Fridays PPF
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Robinson v.s. Friday

• Labor required for

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Robinson v.s. Friday

• Robinson opportunity cost of 1 fish 2 cups of
  berries
• Friday opportunity cost of 1 fish 3 cups of
  berries
• Robinson opportunity cost of 1 cup berries ½
  fish
• Friday opportunity cost of 1 cup berries 1/3
  fish
• In this case, Friday-who has an absolute
  advantage in nothing- has a comparative advantage
  in berry picking.

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Robinson v.s. Friday

• Friday Fish ?3 ? Berries?9
• Robinson Fish ? 4 ? Berries ?8
• So, Robinson more than makes up for the fish that
  Friday is no longer catching, and Friday more
  than makes up for the berries that Robinson isnt
  picking.

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Judging comparative advantage in pictures

• Suppose Friday and Robinson can work 12 hours
  each day separately. There PPF in one coordinate
  plane is as follows

The flatter slope on the PPF indicates a lower
opportunity cost for that goods.  
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Robinsons PPF
2
24
6
Fridays PPF
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Specialization in Perspective

• While specialization gives us material gains
• There may be opportunity costs to be paid in the
  loss of other things we care about
• The right amount of specialization can be found
  by balancing gains against costs