1. ECON 100 Lecture 5
Monday, February 17

2. Annoucements
The first problem set (discussed in last week’s Problem Sessions) + answers are posted on web page To convince you that all questions are easy, here is the first one from PS #1. It is a multiple choice question. (Two of the possible answers are close, this can sometimes be annoying.)

3. from Exercise Set 1, Econ 100 The opportunity cost of an activity is
a. the amount of money spent on the activity.
b. the next-best use of the resources devoted to the activity.
c. any cost that cannot be recovered.
d. the value of the time spent on that activity.
e. any cost other than the direct money cost of the activity.

4. This is the midterm exam version of the same question
The opportunity cost of an activity is
a. the amount of money spent on the activity.
b. the next-best use of the resources devoted to the activity.
c. any cost that cannot be recovered.
d. the value of the time spent on that activity.

5. If you prefer to go to one of the scheduled problem sessions, here is the information.
Tu B6 Mithat Can Ulubay (SOS B08) Fr B1 Ahmet Gülek (SOS B08) Fr B2 Doruk Sırtıoğlu (SOS B07) Fr B4 Sonkurt Kemal Şen (SOS B08) KOLT tutors: Cihan Oklap and Sonkurt Kemal Şen Please be nice to them.

6. Now, finally…

7. The lecture

8. Please turn off laptops, tablets, phones, etc!

9. Please turn off laptops tablets phones etc!

10. A brief summary of nearly everything
Economics assumes that people are rational. Rational people compare costs and benefits when they decide what to do. Rational people use this simple rule “Do activity x if B(x) ≥ C(x)”

11. A brief summary of nearly everything
“Do activity x if B(x) ≥ C(x)” Measuring the costs and benefits of an action is not always easy. People sometimes ignore costs that should be counted: Opportunity cost People sometimes count costs that should be ignored: Sunk cost

12. Brief summary …
The assumption that people do activity x if B(x) ≥ C(x) means that if the costs or the benefits of an action change, rational people change their behavior. This is what economists mean when they say “people respond to incentives”.

13. Brief summary …
When rational people decide on the level of an activity, they compare the additional benefits against additional costs, also called marginal benefit and marginal cost. Start with level 0; increase the level of the activity by one unit at a time as long as the additional benefit from one more unit of the activity is greater than the additional cost.

14. Brief summary …
This rule will make you stop at the level where approximately the additional benefit (marginal benefit, denoted MB) equals the additional cost (marginal cost, denoted MC) MB = MC

15. Why do we study economics?
The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.
Joan Robinson
Joan Robinson ( ) was one of
the great economists of the 20th century.

16. Road map Why are we studying these topics?
Economics is the study of how society manages its scarce resources. In most societies resources are allocated through the combined actions of millions of people and firms (through markets and the political process).

17. Road map What is economics and why these topics?
We start with the study of how people make decisions:
Examples we used were
Should I iron my shirt?
Should I go to the Clapton concert?

18. Road map What is economics and why these topics?
These are some of the important decisions people make
How much education to have
How much to work
Which goods/services to buy
How much to save,
How to invest those savings.

19. What is today’s lecture about?
We will study how people interact with one another. Today’s lecture is about … Specialization, Interdependence, and the gains from trade

20. What is next?
We will examine how buyers and sellers of a good (or service) together determine the price at which the good is sold and the quantity that is sold. We will study topics like Demand Supply Competitive markets The equilibrium in competitive markets

21. and finally, after we have discussed all these …
We will have the first midterm exam.

22. Now, today’s lecture

23. Interdependence and the Gains from Trade

24. We can be economically self-sufficient
We can be economically self-sufficient. or We can specialize and trade with others, leading to economic interdependence.

25. I don’t know much about the tariff
I don’t know much about the tariff. But I know this much, Abraham Lincoln is supposed to have said: “When we buy manufactured goods abroad, we get the goods and the foreigner gets the money. When we buy the manufactured goods at home, we get both the goods and the money.”
quoted in Dani Rodrik, Symposium on Globalization in Perspective: An Introduction, Journal of Economic Perspectives; Fall 1998 pages 3-8.

26. Abraham Lincoln (1809 –1865), is the 16th President of the United States. He served from March 1861 until his assassination. He led the country through a great constitutional, military and moral crisis—the American Civil War—preserving the Union while ending slavery and promoting economic and financial modernization.

28. We will construct a simple economic model to…
Talk about “Interdependence and the Gains from Trade”. This model was first introduced in David Ricardo’s book “Principles of Political Economy and Taxation”, published in 1817.

29. Even if A (Advancedland) is more productive than B (Backwardland) in every economic activity, can both countries still benefit from trade? David Ricardo's “law of comparative advantage” showed that the answer is yes.

30. Principles of Political Economy and Taxation, 1817
David Ricardo is often credited with systematizing economics, and was one of the most influential of the classical economists, along with Adam Smith. He was also a member of Parliament, businessman, financier and speculator, who amassed a considerable personal fortune.

31. David Ricardo's theory of Comparative Advantage is one of the very few statements in economics which is perfectly simple without being perfectly obvious. Paul Samuelson

32. Paul Samuelson (1915 –2009) won the Nobel Prize in Economics in 1970
Paul Samuelson (1915 –2009) won the Nobel Prize in Economics in The Nobel committee said that… Prof. Samuelson "has done more than any other contemporary economist to raise the level of scientific analysis in economic theory". Samuelson is often called the "Father of Modern Economics", and considered by many to be the "foremost academic economist of the 20th century".

33. Interdependence and the Gains from Trade
Imagine a world with two goods, fish and bread; and two countries: Poorland and Richland Each country is populated by a single individual.

34. Technology and resource constraints
Labor is the only scarce resource needed for production. Each person has 30 hours (per week) that can be allocated to fish or bread production.

35. Production technology
The richlander can produce 1 fish in 1 hour and 1 (loaf of) bread in 1.5 hours. The poorlander can produce 1 fish in 3 hours and 1 (loaf of) bread in 2 hours.

36. Remember Ariel Rubinstein?
He is one of the most important and creative economic theorists of our day. His work is in the area of game theory.
“I categorically cannot see any case where game theory could be helpful.”

37. In his own words
After nearly forty years of engaging in this field, I have yet to find even a single application of game theory in my daily life. In my view, game theory is a collection of fables (karga ile tilki) and proverbs (sakla samanı gelir zamanı).

38. In his own words
Are fables useful or not? In some sense, yes. A good fable helps us to see a situation in life from a new angle and perhaps influence our action or judgment one day. But fables are not useful in the sense of giving you advice about what to do tomorrow, or how to reach an agreement between the West and Iran.

39. Let’s think about the…
The Production Possibilities without trade (without specialization) Draw the production possibilities frontier for the two countries, Richland and Poorland.

40. Poorland, Production Possibilities (She has 30 hours, can produce 1 fish in 3 hours and 1 bread in 2 hours)
Bread 15
Slope: rise/run = ‒ 15/10 = ‒1.5 A 9
Fish 4 10

41. Consumption Preferences (tercihler)
Perhaps not very realistic, but very simple, and easy to describe Each person eats fish and bread in fixed proportions in sandwiches that are made with 1 fish and 1 loaf of bread. Any leftover fish or bread is useless. Fractional sandwiches are OK!

42. We will start with the NO TRADE SITUATION Self-sufficiency (autarchy) What will each individual (country) produce if there is no trade? What will each individual (country) consume?

43. Report Card - Richlander - NO TRADE
In Session 1, where I cannot trade with others, I chose to produce ____________ units of fish and _______________ units of bread, and consume ______________ sandwiches. (This has to be the minimum of these two quantities.)

44. Production possibilities
The richlander has 30 hours. She can produce 1 fish in 1 hour and 1 bread in 1.5 hours. The poorlander has 30 hours. She can produce 1 fish in 3 hours and 1 bread in 2 hours.

45. SPECIALIZATION and TRADE
Each country/person will be better off which means that each can consume more sandwiches if they specialize in producing the good they are more suited to produce, and then trade with each other.

46. Report Card - Richlander - WITH TRADE
In Session 2 where I can trade with others, I chose to produce ________ units of fish and ________ units of bread. In my trade with the other country I sell/buy ________ units of fish and sell/buy ________units of bread. After I trade, I have ________ units of fish and ________ units of bread, and I consume ________ sandwiches.
Name of the trading partner _______________

47. Production possibilities
The richlander has 30 hours. She can produce 1 fish in 1 hour and 1 bread in 1.5 hours. The poorlander has 30 hours. She can produce 1 fish in 3 hours and 1 bread in 2 hours.

48. End of the lecture!