The PPF Comparative Advantage & International Trade Lecture 4 Dr. Jennifer P. Wissink ©2015 John M. Abowd and Jennifer P. Wissink, all rights reserved. September 3, 2015

Announcements (MACRO) Fall 2015 u Get yourself set up on MEL ASAP. –MEL Quiz#01 was posted days ago and is due 10am Sept 8. –MEL Quiz#02 was posted this morning and is due 10am Sept 15. –Missing a few MEL deadlines here and there is no big deal – no need to contact me and ask for extensions, forgiveness, etc. I expect people to miss now and again. I would too! That’s why we do the 500 points bit. There will be at least 700 points assigned over the 15 or so MEL quizzes that will be posted between now and early December. (See the syllabus for details.) u Reminder: The Learning Strategies Center supports this class in several ways. –Check it all out on their web pages –Or talk with Albert Alexander up at the Learning Strategies Center u TakeNote covers this class! See next slide.

Increasing MOC: So Why The Bowed-Out PPF Curve? u Two-fold answer: –(1) Heterogeneous factors of production –(2) 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.

Checking For The LDMR: Look At Marginal Product u Consider the marginal productivity of labor in each technology. u Marginal productivity of labor=MP L = (change in output)/(change in labor)

Checking For The LDMR In Guns & Butter GUNS KLGunsMP BUTTER KLButterMP production function for Guns production function for Butter

The PPF’s Bowed-Out Curvature, that is Increasing MOC

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

Location of the PPF: aka PPF Gymnastics G B PPF-old PPF-new u 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 u What happens to the PPF?

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? A.The economy can make more guns, but not more butter as compared to before. B.The economy can make more butter, but not more guns as compared to before. C.The economy is inside its PPF and will move to a point on its PPF. D.The economy can make more guns and more butter as compared to before. E.The economy has to make more guns and more butter as compared to before. G B PPF- old PPF-new

The PPF & MOC Applied to International Trade u Very nice application of PPF. u Nice way to introduce the ideas of absolute advantage and comparative advantage. u 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.

The Idea Of Comparative Advantage & Trade u Specialization and free trade will benefit all trading parties, even when some are “absolutely” more efficient producers than others. u Need to understand absolute vs. comparative advantage. u 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): – son.htmlhttp:// son.html

Absolute vs. Comparative Advantage u Absolute advantage: if your country uses fewer resources to produce a given unit of output than the other country. u Comparative advantage: if your country can produce an output at a lower marginal cost in terms of other goods foregone than the other country. u Every country (or person, or economy) has a comparative advantage at some activity. u 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. u It’s all about comparative advantage.

i>clicker question Suppose the 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? A.England B.Portugal C.Both England and Portugal D.Neither E.Not enough information to know LABOR (L) HOURS REQUIRED ENGLANDPORTUGAL 1 yd. cloth2 hours1 hour 1 barrel wine 40 hours10 hours

i>clicker question Suppose the 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? A.England B.Portugal C.Both England and Portugal D.Neither E.Not enough information to know LABOR (L) HOURS REQUIRED ENGLANDPORTUGAL 1 yd. cloth2 hours1 hour 1 barrel wine 40 hours10 hours

Each Country’s PPF Portugal’s PPF England’s PPF LABOR HRS REQUIRED ENGLANDPORTUGAL 1 yd. cloth2 hours1 hour 1 barrel wine 40 hours10 hours u Assume each country has L=80 hours.

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

MOC of cloth=1/20 bl wine MOC of wine=20 yds cloth W C 2 40 W C The Combined PPF 8 40 Portugal’s PPF MOC of cloth=1/10 bl wine MOC of wine = 10 yds cloth W C 8 80

i>clicker question Given the combined PPF, which one of the following is true? A.Between points A and B on the PPF, both countries are producing both goods. B.Between points B and D on the PPF, both countries are producing both goods. C.At point A on the PPF only England is making wine. D.At point B on the PPF England is making only cloth and Portugal is making only wine. E.At point B on the PPF England and Portugal are each making 4 barrels of wine and 20 yards of cloth. C W B A D

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? A.1/10 a yard of cloth B.1/20 a yard of cloth C.10 yards of cloth D.20 yards of cloth E.10 barrels of wine LABOR (L) HOURS REQUIRED ENGLANDPORTUGAL 1 yd. cloth2 hours1 hour 1 barrel wine 40 hours10 hours

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? A.40 yards of cloth B.1/40 a yard of cloth C.10 yards of cloth D.20 yards of cloth E.20 barrels of wine LABOR (L) HOURS REQUIRED ENGLANDPORTUGAL 1 yd. cloth2 hours1 hour 1 barrel wine 40 hours10 hours

Exchange Rates

u 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.  French MOC of cloth=1/15 bls  French MOC of wine=15 yds W W W W C C C C The Combined PPF With 3 Countries! Portugal’s PPF England’s PPF 3 45 France’s PPF 13

An International Cloth Supply Curve