1. Professor Chris Wimmer Oct 23 2007
Lecture 2 i.) Trade and Comparative Advantage ii.) Market Forces: Demand
Professor Chris Wimmer
Oct

2. Production Possibilities
In a set time frame with set resources the production possibility frontier shows options for production
Lets draw one!
All points on or inside the line are possible
Where is the most desirable points?
The straight line means you can substitute production for each good evenly along line!!!

3. Consumption possibilities before and after trade
If a person does trade, their production possibility frontier is also their consumption frontier
Let’s look at a trading example!

4. Absolute Advantage
A producer that requires less inputs to produce a product has absolute advantage
In the example we use with farmer A and B, time is the only input!

5. Comparative Advantage
To find comparative advantage we go back to our concept of opportunity cost
Let us find the opportunity costs in our silk and rice example
It is impossible for someone to have comparative advantage in both traded goods in our example, unlike absolute advantage. Why?
Because the opportunity cost of one good is the ‘inverse’ of the other good

6. Who has comparative advantage in what goods?
The farmer A has comp adv in silk
The farmer B has comp adv in rice
Why?
What does this mean for trade?

7. Gains for trade. Absolute or Comparative Advantage counts?
It is in comparative advantage that we can gain from specialization and trade
Each person should specialize in the product that they have comparative advantage  increase economy and benefits all involved in trade
But for both people to benefit, the price of trade must be between both farmer’s opportunity costs for the good.

8. Our example
Farmer A concentrates on silk producing 64 pounds. Add 24 from Farmer B and the economy now produces 88 pounds which is greater than before with
Farmer B concentrates on rice production producing 36 pounds for a total of 36 which is greater than with no specialization/trade at 32

9. How has opportunity cost changed with trade?
Before farmer A had to give up 4 pounds of silk for 1 of rice  Now he gives only 3 pounds for a pound of rice (30 for 10)
Before farmer B had to give up ½ a pound of rice for a pound of silk  Now he gives up 1/3 pound of rice for a pound of silk
Both gain from trade!!!

10. Rule of gains from trade and comparative advantage
Notice that the opportunity cost of both goods lies between the old opportunity costs of farmer A and B
This has to be the case for both farmers to gain from trade!

11. Homework Read Chapter 3 Do Pg. 59  60 Q# 1, 2, 3, 4, 5
Pr. # 1, 2, 3, 4, 5, 6, 7, 8, 9

12. ii.) Market Forces: Demand
What is a market?  a network of buyers and sellers for a product or good.
The demand is made up of the buyers while the sellers decide on the supply.
A competitive market has many buyers and sellers! Can one seller/buyer affect the price/quantity?

13. Perfectly Competitive Markets
1. Must have many buyers and sellers so individuals can not affect market price.
2. Goods being sold are identical
*3. All buyers and sellers have perfect information about products
*4. There are no transaction costs
*5.There are no externalities

14. The Demand Curve
The quantity demanded is the amount consumers are willing and able to buy at a certain price
Quantity demanded is negatively related to price
This is the Law of Demand Quantity demanded goes down as price goes up

15. Demand Schedule
This shows the relationship between price and quantity on a chart.
Lets create a demand schedule and then graph it on a demand curve!

16. Building market demand from individuals
The market demand is the sum of all individuals in society who have a demand for a certain products
This is holding all else constant except price
Let’s do an example about chocolate bars (SL16,L2)

17. Reasons for Demand Shifts
Income – if your income falls you would want less of a Normal Good and demand would fall
What is an inferior good?
Substitution – Goods that are very similar will affect each others demands
Complements – goods that are complements will have a positive relationship!

18. (Continued)
Tastes – When people change their tastes for something, demand shifts.
Expectations – your demands today will change depending on your expectations for future
Number of buyers – if the number of buyers increases, demand increases

19. The Supply Curve
This curve represents the sellers desire to supply goods at each price level.
Price and the supply curve are positively related
Law of supply is that as price goes up, the supply of goods increases

20. Supply curve and market supply
Building the market demand for supply is very similar to the example we did for demand so let’s look at the example in the book, pg. 73
Let’s also go through shifts in the supply curve

21. Reasons for shifts in the supply curve
Input prices: this affects the cost of producing so also supply
Technology: new technology may make production cheaper or faster
Expectations: A firm must always think about future demands, prices, and costs
Number of sellers: The more sellers, the greater the supply.

22. Supply and Demand: Equilibrium
This is where we find price and quantity