Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Introductory Economic Models

1

Two PPFs, Specialization, and Absolute Advantage

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So now let's extend our discussion of PPS to include the idea that different people and that could be firms or even countries have different levels of productivity, which leads them to have different PPS. So a quick note I want to make is that we are going to be using linear PPS in this module as you can see on the graphs. Um, it just makes the math easier and that's just how the textbooks do it. So it's just how we're gonna do it here. Other than that, the assumptions remain the same. We still got two goods, fixed technology, fixed resources. Right? So let's move here onto the graphs. So the idea here is that you, our, let's say president of the economics club at your university and you're doing a big old economics bash and your friend just joined a fraternity is also throwing a big old bash as well. And what we have on our curve, we've got the two key essential ingredients for any good party. Of course, I know you're all yelling at once. It's pizza rolls and hunch punch, Right? Um, and that's what you are producing here. So let's look on the graphs and see what your production possibilities are. So you being an economics major here, um, are only able to produce if you only did hunch punch, you get 20 hunch punch. Well, I guess let's say gallons, right? You're getting 20 gallons of hunch punch here. Um, and if you were to only produce pizza rolls and neglect the hunch punch, which I think is a bad idea, you would get a total of 10 pizza rolls? Well, let's say 10 batches of pizza rolls, right? 10 pizza rolls isn't gonna feed many people. Um and let's look at your friends graph over here for hunch punch. Um, if they were to produce only hunch punch, they would get 30 gallons out of it. Um, the same here with the pizza rolls, they would also get 30 batches of pizza rolls down here. If they were to create pizza rolls, whips. Uh, so you'll see it looks like your friend is gonna have have a much better bash than you are. Right? They've got the resources, they've got the know how of how to make hunch punch of pizza rules, they're gonna have a better, better bash than you. Well, what if I could tell you that you could even be better off than your current situation. If you guys were able to specialize and trade? And that is exactly what I'm going to show you now. How did each of you have a better bash than you could just by yourselves. So, let's go ahead and define specialization. So, specialization is going to be producing the goods you are best at producing? All right. So, we have to define how, how do we know what you're best at producing, what is best, right, You can produce 2020 gallons of hunch punch, but only 10 pizza rolls. Are you best at hunch punch? Or are you best at pizza rolls? Right. What can we say? Yes, you can make more hunch punch, but how valuable is it? So let's look at these two ways to think about how we are best at something. First, let's talk about absolute advantage. So, absolute advantage. And let me get out of the way here, absolute advantage is being is producing more of a good with the same amount of resources. Right? So you both have the same amount of time to produce to prepare for this party. Who can make more of that of that? Good? Right. So, first, let's think about the pizza rolls, who can make more pizza rolls? Just given the amount of time, who has the absolute advantage in pizza rolls? It's your friend, right? She can make 30 pizza rules, whereas you can only make 10. Um And let's do the same for hunch punch. Well, it looks like you can make 20 hunch punch and your friend make 30. So it seems your friend has the absolute advantage in both. And you're probably thinking like, well, how can we even trade? How can my weak production even match her production of pizza rolls and hunch punch at this level? Well, the answer is that we are going to be looking not for an absolute advantage, but we are going to look for a comparative advantage. All right, there's always a compare advantage when you are dealing with two separate PPS, someone is always going to have a comparative advantage in one and the other person, a comparative advantage in the other. Good. Okay, So comparative advantage is defined as producing a good at a lower opportunity cost. Okay, So we are going to define how we calculate the opportunity cost now, and we are going to do that in the next video. So let's go ahead and follow along.

2

Opportunity Costs and Comparative Advantage

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Alright. So here we just have the graphs from the previous page. Um and let's go ahead and continue the discussion of comparative advantage. So, comparative advantage we said producing a good at a lower opportunity cost. Right? The lower opportunity cost. Remember whenever you have two PPS, two different PPS like this? Um One person is always going to have the the comparative advantage in one product and the other person a comparative advantage in the other. So it's just a matter of finding out who has which comparative advantage. All right, let's go ahead and start figuring out opportunity cost. So, we've got the steps to do it here. The first thing you're gonna do is choose an individual. So first we're going to calculate either your opportunity costs or your friends opportunity cost. Right? Then we are going to identify the maximum for each good. So, we're only going to look at one graph out of time here. That's what I'm trying to portray. First. We're going to look only at your graph and then we'll look only at your friends graph. Alright. We want to identify the maximum. So the maximum pizza rolls. If you didn't make hunch punch, right, what is the maximum amount of pizza rolls you can make and the maximum amount of hunch punch. If you made no pizza rolls. And then we're gonna use this formula. Very simple. We're just gonna do a division. You just have to be careful which ones on the top and the bottom. When you're finding the opportunity cost of, say pizza rolls, then pizza rules is on the bottom. Right? So you're gonna divide max hunch punch divided by max? Pizza rules is going to give us the opportunity cost of one pizza roll. And you can imagine it's vice versa for hutch punch. So, let's start with your opportunity cost of one pizza rolls. Alright, So let's go to our graph and let's find the maximum pizza rolls and maximum hunch punch that you can make. So on our graph before we had shown this as well, you could make 20 gallons of hunch punch or 10 batches of pizza rolls. Right? So, your max hunch punch hunch punch for you. The max hunch punch is going to be 20 and the max pizza rolls pr for pizza rolls is going to be 10. Okay, So let's take that information down here to the graph. Right? So, your max hunch punch was 20. Your Mac's Pizza Rules was 10. All right. So, if we're looking for the opportunity cost of one pizza rolls for you. We're gonna take our max hunch punch of 20 divided by our max. Pizza rolls 10 20 divided by 10, gives us two. So, the opportunity cost of one pizza rolls for you. What is this to its to hunch punch that you're gonna have to give up. You're gonna give up two gallons of hunch punch for every pizza roll that you want to create? All right, let's do the same thing with hunch punch. What's your opportunity cost of hunch punch. Right? So, we have the same numbers, right? We're still dealing with your graph. So, your max hunch punch is 20. Your Mac's pizza rolls is 10. So, we're gonna do the same thing. Remember it's the opposite now, since hunch punch is what we're looking for. We're looking for the opportunity cost of punch punch punch, punch is what's on the bottom of the of the fraction. So, we're gonna have the opposite here, illustrate. Um We've got 20 on the bottom because we're doing hunch punch. So hunch punches on the bottom. Pizza rolls on top 10. And we are going to get 10 divided by 20 Is half right? Which is equal to 0.5. You are giving up 0.5 pizza rolls. So, half a pizza roll for every gallon of hunch punch. So every time you want one more gallon of punch punch, you're gonna have half of a pizza roll less. Okay, let's do the same thing for your friends graph. So, let's find your friends. Maximum pizza rolls and your friends. Maximum hunch punch. So, if we look on the graph, the maximum amount of hunch punch up here was 30 right? 5, 10 15 2025 30. Same over here. Pizza rolls 30. So she actually has for both A max of 30. So try and think of what that's gonna do to the fraction. Right? Let's go back down here and put this information in. Um we've got uh let me go to the top here. So I'm not in the way. Alright, so we've got hp her maximum hunch punch was 30, right? Her maximum pizza rules was also 30. So in this case um it's hard to mess up the fraction, but let's do it in the correct order. Anyways, when we're doing the opportunity cost of pizza Rolls max, pizza rules is on the bottom. So the max pizza rolls was 30 max, hunch punch was 30. We're going to get one, right? So for each additional pizza roll, she's gonna have to give up one gallon of hunch punch. Okay? And for you, excuse me, for hunch punch. Um we're gonna have those same numbers, right? But now hunch punches on the bottom. So the hunch punch, 30 is on the bottom. The pizza rolls 30 is on top. And we are going to get one pizza rolls. So for every gallon of hunch punch your friend wants to produce. He has to give up one pizza roll. So now we can figure out who has the comparative advantage in each product. Over here, we'll put the comparative advantage in pizza rolls. And over here, the comparative advantage in hunch punch. Alright? So to see who has the comparative advantage, we have to see who has the lower opportunity cost. So we're talking about Pizza Rolls every time you want one more pizza roll you give up to hunch punch your friend when she wants one more pizza roll, she gives up one hunch punch. Your friend has the comparative advantage in pizza roll production, right? She has a lower opportunity cost for each pizza roll that she creates. All right. Keep your fingers crossed because you need to have a comparative advantage here or you're just useless. So let's see what we get hunch Punch. Your opportunity cost of hunch Punch is half a pizza roll, 0.5 pizza rolls. While your friends opportunity cost of hunch punch is one pizza roll for each additional gallon. You only have to give up half a pizza roll while your friend has to give up an entire pizza roll. So hallelujah, you have a comparative advantage in hunch punch creation because your opportunity cost is lower. Cool. Alright guys, let's move on and see how this affects the trade.

3

Problem

Who has the absolute advantage in making scrambled eggs?

A

Joe

B

Carla

C

No one

4

Problem

Who has the absolute advantage in making fresh squeezed orange juice?

A

Joe

B

Carla

C

No One

5

Problem

Who has the comparative advantage in making scrambled eggs?

A

Joe

B

Carla

C

No one

6

Problem

Who has the comparative advantage in making fresh squeezed orange juice?

A

Joe

B

Carla

C

No One

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