Economics 2010 Lecture 4 Growth and Trade Rober Martinez-Espineira.

Economics 2010Economics 2010

Lecture 4

Growth and Trade

Rober Martinez-EspineiraRober Martinez-Espineira

Growth and TradeGrowth and Trade

QUIZ1 WEEK 5 (Fri OCT 14th)

Growth and TradeGrowth and Trade

Economic growthGains from tradeThe evolution of trading

arrangements

Economic GrowthEconomic Growth

economic growth = expansion of production possibilities

Why do production possibilities expand?


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

Determinants of Economic Determinants of Economic GrowthGrowth

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 in a factory

Install more capital or adopt new technology


Economic growth in a household

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


Economic growth in a nation

Invest in new technologies, and capital, including human capital,

Gains from tradeGains from trade

Everyone gains from tradeTrade is not a zero-sum game The source of gain is comparative advantageA 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


Mark can produce jeans or skirts

For Mark, 1 skirt costs 0.5 jeans

Or, 1 pair of jeans costs 2 skirts


Marjorie can produce jeans or skirts

For Marjorie, 1 skirt costs 0.08 jeans

Or, 1 pair of jeans costs 12.5 skirts


Let’s look at these two PPFs on a single picture

Suppose each produces the same quantities


How can they gain from trade?

By specializing in the activity at which they have a comparative advantage

Gains from tradeGains 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 tradeGains 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 tradeGains 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 tradeGains from trade They each can

operate outside their individual production possibilities frontiers

Evolution of trading arrangementsEvolution 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!

Liz's opportunity cost ofproducing 1 smoothie is 1 salad.

Liz's opportunity cost of producing 1 salad is 1 smoothie.

Gains from Trade: one person has the absolute Gains from Trade: one person has the absolute advantage at making both goodsadvantage at making both goods

Liz's Smoothie Bar

In an hour, Liz can produce 40 smoothies or 40 salads.

Liz’s customers buy salads and smoothies in equal number, so she produces 20 smoothies and 20 salads an hour.

Joe's opportunity cost ofproducing 1 smoothie is 5 salads.

Joe's opportunity cost ofproducing 1 salad is 1/5 smoothie.

Gains from TradeGains from TradeJoe's Smoothie Bar

In an hour, Joe can produce 6 smoothies or 30 salads.

Joe spends 10 minutes making salads and 50 minutes making smoothies, so he produces 5 smoothies and 5 salads an hour.

Gains from TradeGains from Trade

Liz’s Absolute AdvantageAbsolute advantageWhen 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.


Liz’s Comparative AdvantageLiz’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.


Joe’s Comparative AdvantageJoe’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.


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.


Liz and Joe 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:• 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.


Gains From TradeGains From Trade

Joe initially produces at point A on his PPF.

Figure 2.7 shows the gains from trade.

Liz initially produces at point A on her PPF.

Gains From TradeGains 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 TradeGains 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 TradeGains From Trade If Joe specializes in producing salad, he produces 30

salads an hour at point B on his PPF.

Gains From TradeGains From Trade If Liz produces 25 smoothies and 5 salad an hour, she

produces at point B on her PPF.

Gains From TradeGains 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 TradeGains 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 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 arrangementsEvolution 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 termsKey terms

opportunity cost absolute advantage comparative advantage specialization trade property rights market

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Any questions about today’s stuff?Demand and SupplyRead Parkin’s Chapters 3 and 4!!!

Economics 2010 Lecture 4 Growth and Trade Rober Martinez-Espineira.

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