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

Introductory Economic Models

1

Comparative Advantage and Trade

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Okay, so now let's take our knowledge about comparative advantage and see how both parties can be made better off through trade. So like I told you before, it is possible to reach levels of consumption outside our PPF through specialization and trade. Right? So up to now we've only been able to get as much as our PPF allows, but through trade we can actually reach levels outside of that. And the way we're gonna trade is for both producers to specialize in the product where they have a comparative advantage. Right? This has been the theme for a minute here, comparative advantage. And remember the comparative advantage is who has the lower opportunity cost. So here we have those graphs from before where you and your friend are throwing your awesome bashes with your pizza rules and your hunch punch. And in a previous video, right, we calculated these opportunity costs of pizza rules and hunch punch for you and your so like I said, we are going to specialize where we have our comparative advantage, where we have the lower opportunity cost. So who has the comparative advantage in pizza roll production? Well, for you, it's to hunch punches per pizza rule for your friend. It's one hunch punch per pizza roll. Um so your friend has that comparative advantage, um your friend will make the pizza rolls and you will make the hunch punch, right? Just like I told you, um whenever someone has the comparative advantage in one, the other person has to have the comparative advantage in the other. Alright, so you are going to be making the pizza rolls with the opportunity cost of Just excuse me, you're gonna be making the hunch punch with an opportunity cost of just half a pizza roll. Um so let's look at what you and your friend look like before trade. So before trade, you are gonna have only hunch punch because you're gonna make all the hunch punch that you can and then trade with your friend. So back on the graph, right? You can make 20 hunch punches. So, we're gonna make the maximum amount of hunch punch. You're gonna have 20 hunch punch and zero pizza rolls before the trade. And your friend is gonna make 30 pizza rolls and no hunch punch, right? She's gonna maximize her pizza rule output and make 30 pizza rolls and zero hunch punch. So the idea here is that we're gonna set a price for the trade at 1.51 point five gallons of hunch punch for one pizza. All right. Most of the time you're just gonna be given what the trade is, what the price of the trade is gonna be what what the terms are. Um But some books go into a little more depth than if yours does. We'll do that as well. But for now we're just going to take it at face value. 1.5 gallons of hunch punch for one pizza. Alright. So let's go ahead and calculate where we're at when we make these trades. So we could trade different amounts of hunch punch and pizza, right? There's no certain amount we have to trade. So let's see what happens at different levels of trading first. They were gonna trade five pizza rules for how many gallons of a hunch bunch. So let's do that math, if we have five pizza rules and we get 1.5 gallons uh per pizza rule, so it's five times 1.5 is going to give us the amount of gallons. So it's going to be 7.5 gallons. We'll do it in black here, 7.5. Actually, I'll do it in red. Yeah, 7.5 gallons of hunch punch. Um and let's see what happens when we make that trade. So you started with 20 hunch punches, right? And you're gonna give up 7.5. So you're going to be left, whoops, let me do that down here. You start with 20 hunch punches and you give up 7.5, you're left with 12.5 gallons of hunch punch. And you had zero pizza rolls and you traded up and you got five pizza rolls from your friend. So you have five pizza rolls and 12.5 hunch punch. Right, let's see what that looks like on the graph. So you're now at a point where you have five pizza rules and 12.5 hunch punch. So you are right here at five pizza rolls and 12.5 punch punch, which is gonna be in the middle of this line right here and look at where we are, We've we are outside of our PPF. We are at a point that we could not produce just by ourselves. Isn't that exciting? We were able to get more value just through this trade and now our party is gonna be even more fun. Cool. Let's see what happens with these other possibilities. So, let's see your friend after the trade in the same situation, right? Your friends started with 30 pizza rules And she gave you five. So she's down to 25 pizza rolls. And she's gonna get 7.5 gallons of hunch punch in this trade. So, let's see where that is on her graph. So, she's got um 25 pizza rolls left over here And 7.5 gallons of hunch punch. Look at her, she is having quite a ball here, right? She's getting more hunch punch than she could have produced by herself at that level. All right, so let's go on with some of these other examples just to do the math. So now we've got a trade of 10 pizza rolls. And when we've got 10 pizza rolls times the 1.5, that's gonna give us 15. Let me go back to red 15 gallons of hunch punch. Right? So, you're gonna do 20 minus 15 and you're left with five gallons of hunch punch. And you got 10 pizza rolls for it. And how about your friend, your friend started with 30 pizza rolls. She traded you 10 of them, right minus 10. She's left with 20 pizza rolls. And how about her hunch punch? She didn't have any, she didn't produce any and you gave her 15. So she's at 20 pizza rolls and 15 hunch punch. So let's start with yours, 10 pizza rolls and five hunch punch. Let's put that on your graph. 10 pizza rolls and five hunch punch. So we've got 10 pizza rolls. Five punch punch. That's a spot right there on the graph. Cool, so you're still outside your PPF, you're getting more value than you could just buy yourself. How about your friend, your friend had 20 pizza rolls and 15 hunch punch at this level of production. So let's see where that is. Here's 20 pizza rules And 15 hunch punch. That's gonna put her way up there. Alright, so she's getting some value in that trade. Cool, let's go on to the next one, trading 13.33 pizza rolls. That's a weird number why he picked that. Um let me get out of the way here for these last examples. So 13.33. If we multiply that by the price of the trade that 1.5, that's gonna get us up to 20. So I did that because that's the maximum amount of gallons of hunch punch that you have right to trade with your friend. So you are gonna trade 20 away. And you're gonna be left with no hunch punch at this point. Um And your pizza rolls, you're gonna get 13 right 130.33 pizza rolls in that situation. And how about your friend? She started with 30 pizza rolls and she's giving up 13 point whoops. 13.33. That's gonna leave your friend with mental math. 16.67 pizza rolls and 20 gallons of punch. Punch. Alright, so let's see where that ends up on the graph. Um Let's start with yours, 13.33 pizza rolls and zero hunch punch 13.33. No punch punch. But that's gonna put us somewhere, let's say around here, Right? So look at that. Even if we had just wanted to make only pizza rules and didn't want any hunch punch, we could trade away all our hunch punch and have more pizza rolls than when we if we had tried to do it ourselves. All right. So, what you're gonna see appearing here, Um is what's called the trading line. Right? So this line that I'm drawing now, that's kind of your production possibilities with trade, right? So it kind of expanded just a little bit with the trading ability that you have. And let's do your friends here at at this level of production or this level of trading. So we've got um 16.67 pizza rolls and 20 hunch punch. So she's getting 20 hunch punch. And about 16. Let's say that's about right there. I would say something like that. Um Yeah, cool. So we're gonna we're gonna do one more. So you see that her line can actually extend a little more. Let's do this last example here. Trade 30 pizza rolls. Look, you don't you don't even have enough hunch punch to trade her for 30 pizza rolls, Right? But let's say there were other people she could trade with and find this price outside the market. Um She she would be able to trade even more of her pizza rolls away. So 30 times the price of 1.5, right? That gets her Uh 45 gallons of hunch punch for her. 30 pizza rolls. Let's not even bother with this box right here, because you don't even have enough to do this. Trade, it's not really gonna be significant on your graph. Um But let's do it for your friend. So your friend um started with 30 traded away all 30 and has zero pizza rolls left, and she got 45 hunch punch fore it. Right? So now she's in a position to have zero pizza rolls and 45 punch punch. If she could find the trading partners for it. Right? So her graph. Look, it even goes beyond this graph here, right? 45 is gonna be somewhere way up here. So you're gonna see her trading line, I'll do it in black as well. Uh kinda go way this way. Right, So, oops, here we go. This is the real test. Can I do this? Pretty good. Pretty good. All right. Not a plus, but that's what it's gonna be. All right, So, let me come back in here. So there you go. That's her trading line right there, right. She can increase her production possibilities by trade as well, so everyone's better off through the trade. Cool. So, I hope you guys got something out of that. Right? Comparative advantage and trade. Alright, let's do this.

2

Problem

If Joe and Carla plan to specialize and trade, what should Joe produce?

A

Only Scrambled Eggs

B

Only Fresh Squeezed

C

6 Eggs and 4 OJ

D

2 Eggs and 4 OJ

3

Problem

If Joe and Carla plan to specialize and trade, what should Carla produce?

A

Only Scrambled Eggs

B

Only Fresh Squeezed

C

6 Eggs and 6 OJ

D

10 Eggs and 2 OJ Orange Juice

4

Problem

Assume that Joe and Carla will trade Scrambled Eggs and Fresh Squeezed Orange Juice at a rate of 1.2 Eggs for 1 OJ. If Joe’s consumption after trade includes six eggs, what will be Carla’s consumption after trade?

A

6 Eggs and 6 OJ

B

0 Eggs and 12 OJ

C

6 Eggs and 7 OJ

D

1.2 Eggs and 11 OJ

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