1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-1 Chapter 2 Comparative advantage: the basis for exchange

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-2 Comparative advantage: the basis for exchange What do you think? –Do the Nepalese perform their own services because they are poor or are they poor because they perform their own services? –Should a top-flight patent lawyer, Bill, write his own will if he can write the will in half the time that a solicitor would take?

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-3 Exchange and opportunity cost Absolute advantage –When one person is able to produce a good or service, or perform a given task, with less resources than another person. Comparative advantage –When one person’s opportunity cost of producing a good or service, or of performing a given task, is lower than another person’s opportunity cost.

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-4 Exchange and opportunity cost The principle of comparative advantage –Should Birkhaman collect his own firewood and repair his own shoes? Time to collect firewood Time to repair shoes Birkhaman 20 minutes 10 minutes Aadesh 30 minutes Productivity information for Birkhaman and Aadesh

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-5 Exchange and opportunity cost Opportunity costs for Birkhaman and Aadesh Opportunity cost of bundle of firewood Opportunity cost of a shoe repair Birkhaman 2 shoe repairs 0.5 bundle of wood Aadesh 1 shoe repair 1 bundle of wood

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-6 Exchange and opportunity cost The principle of comparative advantage –Birkhaman has a comparative advantage in shoe repairs as he has a lower opportunity cost in this activity and should specialise in shoe repairs. –Aadesh has a comparative advantage in firewood collection as he has a lower opportunity cost in this activity and should specialise in firewood collection.

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-7 Exchange and opportunity cost Specialisation increases the total number of shoes repaired and bundles of firewood collected. If they split their time evenly and do both activities Birkhaman Aadesh Bundles of firewood Shoes repaired 1242412 Total 1636

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-8 Exchange and opportunity cost The principle of comparative advantage If they specialise in their comparative advantage Birkhaman Aadesh Shoes repaired 016480 Total 16 48 Bundles of firewood

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-9 Exchange and opportunity cost The principle of comparative advantage –Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-10 Exchange and opportunity cost Thinking as an economist –Coaches of very young soccer players generally encourage players to try out a variety of positions on the team. As they grow older why do coaches insist that each player concentrate on one or two positions?

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-11 Exchange and opportunity cost Sources of comparative advantage –Individual  Inborn talent  Education  Training  Experience –National level  Natural resources  Cultural institutions

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-12 Exchange and opportunity cost Thinking as an economist –Televisions and videocassette recorders were developed and first produced in the United States. –Why did the United States fail to retain its lead in these markets?

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-13 Comparative advantage and production possibilities The production possibilities curve –A graph that describes the maximum amount of one good that can be produced for every possible level of production of another good. –Assume  A small economy that produces only two goods - coffee and nuts. has only one worker, Jara, who works 6 hours per day.

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-14 Jara’s production possibilities 0 Coffee (kg/day) Nuts (kg/day) Opportunity cost (OC) 1.Jara’s OC nuts = Loss in coffee/gain in nuts 2. Jara’s OC coffee = Loss in nuts/gain in coffee 16 8 48 24 Production possibilities curve: All combinations of coffee and nuts that can be produced with Jara’s labour A B C D 12

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-15 Jara’s production possibilities Attainable point: Any combination of goods that can be produced using currently available resources. All points either on or below and to the left of the PPC are attainable. Unattainable point: Any combination of goods that cannot be produced using currently available resources. All points lying above and to the right of the PPC are unattainable.

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-16 Attainable and efficient points on Jara’s production possibilities Nuts ( kg/day) A B Combination F: Unattainable C Combination E: Inefficient D Combinations A, B, C and D: Efficient Coffee (kg/day) 24 0 16 8 4812

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-17 Comparative advantage and production possibilities Efficient point –Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other. Inefficient point –Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other.

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-18 Individual productivity and the slope and position of the PPC 0 Nuts (kg/day) How individual productivity affects the slope and position of the production possibilities curve Peng’s production possibilities curve for a 6-hour day Coffee (kg/day) 4 8 816 A B C D 12 Peng’s production possibilities curve: All combinations of coffee and nuts that can be produced with Peng’s labour 24

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-19 Individual production possibilities curves compared Nuts (kg/day) 0 12 24 Peng’s production possibilities curve Peng has an absolute and comparative advantage in picking nuts. 24 12 Jara’s production possibilities curve Jara has an absolute and comparative advantage in picking coffee. Coffee (kg/day)

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-20 Production without specialisation Nuts (kg/day) 0 12 24 1224 Jara’s production possibilities curve Assume: Jara and Peng allocate their time so each person’s output is half nuts and half coffee Peng’s output = 2 hrs picking nuts = 8 kgs 4 hrs picking coffee = 8 kgs Jara’s output = 2 hrs picking coffee = 8 kgs 4 hrs picking nuts = 8 kgs Total output = 16 kgs each 8 8 B Peng’s production possibilities curve Coffee (kg/day)

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-21 Production with specialisation Nuts (kg/day) 0 12 24 1224 Jara’s production possibilities curve Peng’s comparative advantage is in nuts so he specialises in nuts and produces 24 kgs. Jara’s comparative advantage is in coffee so she specialises in coffee and produces 24 kgs. Jara gives Peng 12 kgs of coffee for 12 kgs of nuts. E Peng’s production possibilities curve Coffee (kg/day)

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-22 Comparative advantage and production possibilities The gains from specialisation grow larger as the difference in opportunity cost increases. –For example  Jara: 5 kg coffee/hr 1 kg nuts/hr  Peng: 1 kg nuts/hr 5 kg coffee/hr

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-23 Comparative advantage and production possibilities The gains from specialisation grow larger as the difference in opportunity cost increases. –Without specialisation Peng: 5 hrs coffee = 5 kg 1 hr nuts = 5 kg Jara: 1 hr coffee = 5 kg 5 hrs nuts = 5 kg Total: 10 kg 10 kg

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-24 Comparative advantage and production possibilities The gains from specialisation grow larger as the difference in opportunity cost increases. –With specialisation Peng: 30 kg coffee 0 kg nuts Jara: 0 kg coffee 30 kg nuts Total: 30 kg 30 kg

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-25 Production possibilities curve for a large economy Nuts (1000s of kg/day) Assume: An economy with millions of workers, that produces only two goods, coffee and nuts 100 80 Why would the production possibilities curve have an outward bow? Coffee (1000s of kg/day) E A B C D 15 20 90 95 203075 77

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-26 Comparative advantage and production possibilities The low-hanging-fruit principle and increasing opportunity cost –In expanding the production of any good, first employ those resources with the lowest opportunity costs, and only afterward turn to resources with higher opportunity costs.

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-27 Economic growth: an outward shift in the economy’s PPC Coffee (1000s of kg/day) Nuts (1000s of kg/day) Original PPC New PPC Factors shifting the PPC 1. Increases in productive resources (i.e. labour or capital) 2. Improvements in knowledge and technology (e.g. Australia, New Zealand)

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-28 Factors that shift the economy’s production possibilities curve Increasing productive resources –Investment in new factories and equipment –Population growth Improvements in knowledge and technology –Increasing education –Gains from specialisation

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-29 Factors that shift the economy’s production possibilities curve Why have countries like Nepal been so slow to specialise? –Low population density –Isolation Some factors that may limit specialisation in other countries –Laws –Customs

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-30 Factors that shift the economy’s production possibilities curve Can we have too much specialisation? What do you think? –What are the costs of specialisation?

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Principles of Microeconomics by Frank, Bernanke and Jennings Slides prepared by Nahid Khan 2-31 Comparative advantage and international trade Economic naturalist –Can there be a possibility of too much of a good thing? –If trade between nations is so beneficial, why are free-trade agreements so controversial?