GAINS FROM TRADE

Tenzin Yindok
 PPF- PRODUCTION POSSIBILTY FRONTIER

Learning Outcomes
• Upon successful completion of today’s class and related homework, you
should be able to:

1. use production possibilities curves to illustrate key economic principles.

2. distinguish between absolute advantage and comparative advantage.

3. determine who should specialization in what task, according to comparative

advantage, in simplified settings.

4. show that there are gains from specialization and trade, in simplified
settings.

5. apply the principle of comparative advantage to your life.

Activities:
Overview

• Differences in opportunity costs between two agents will result in gains from
trade for both, even if one is better at everything

• explains modern life: we buy most things we consume

• determines international trade

if people do different thing they will gain/ benefit/ saving time

we dont produce everything that we consume \
A Simple of Model of Specialization and Trade
model i are assumptions and they simplify things and help with the issue that
we are studying
• Assumptions:
• two producers, Nancy and Joe nancy 3 apples or 3
coffee
• each has 10 hours in a day joe- 1 apple or 1/2 coffee

• they can only produce two products: apples and coffee

Apples Coffee
Nancy 3 kg per hour 3 kg per hour
Joe 1 kg per hour 0.5 kg per hour productivity
table

feasible- possible
production table
In a day: Apples Coffee
Nancy 15 kg 5 hours 15 kg 5 hours

Joe 2 kg 2 hours 4 kg 8 hours

how they can use time in the day\

example of how they use their time
 Production Possibilities Frontier
When on ppf .. When we use all the resources More of one good means less
nancy joe of another good
When under ppf - no fuller utilization of resources

coffee

apples

axes will have quantities possible combinations nancy can produce with given resources and time

intersaction-- point of origin

Production Possibilities Frontier

• Efficient: only way to get more of one good is get less of the other

• Feasible: an output combination that can be produced given the resources

available.

• Infeasible: an output combination that is not feasible given the resources

available.

• Production Possibilities Frontier: all output combinations where all

resources are efficiently being used.
Absolute Advantage
when one can produce more output per input with same resources as compared to others

• Definition: person/ firm/ country has an absolute advantage in an activity if

they require fewer inputs per unit of output than others.

Productivity Apples Coffee

Nancy 3 kg per hour 3 kg per hour
Joe 1 kg per hour 0.5 per hour

• !!"##$%& : Nancy
• !!'())%% : Nancy
Calculating Opportunity Costs
Productivity Apples Coffee
Nancy 3 kg per hour 3 kg per hour
Joe 1 kg per hour 0.5 per hour

OC of 1 apple- quantity of coffee sacrificed per apple

012233
()*+, +.//&& 4156 ;
• !"#$$%&' = = = =1 unit of coffee
)$$%&' 78893: ;
4156

apple/ coffee 3/3= 1

()*+, =
• !"=.//&& =

>.&
• !"#$$%&' = 0.5

>.&
• !"=.//&& = 2
Using PPF’s
• What do the intercepts of the PPF represent?
maximum production of each good that means just producing one thing and producing none units of others

• What does the absolute value of the slope of the PPF represent?

| slope | -- is the opportunity cost of one unit of the good on the x-axis( apple - in our case)
 Lowest in a group

Comparative Advantage if different one will gain

comparitive advantage-- when we have lower opprtunity cost as compared to others

• Definition: a person/firm/country has a comparative advantage in producing

a good or service if the opportunity cost of producing it is lower for that agent
than for others.
ALTHOUGH NANCY IS BETTER( MORE PRODUCTIVE) AT BOTH, JOE HAS COMPARITIVE ADVANTAGE IN
APPLES
Opportunity cost Apples Coffee
Nancy 1C 1A

Joe 0.5C 2A

• !"#$$%&' :
• !"()**&& :
• In one day, Karan can bake 10 cookies or mix 15 glasses of lemonade.

• His friend, Ava, can make 10 cookies or 10 glasses of lemonade.

• His other friend, Santo, can make 10 cookies or 20 glasses of lemonade.

• Who has comparative advantage in making cookies?

a. Karan
b. Ava
c. Santo
d. Both Karan and Ava
e. No one
Gains from Trade

• Before:

Production per day: Apples Coffee

Nancy 15 kg 15 kg
Joe 2 kg 4 kg

• Proposed production: (move production from high OC to low OC)

Production per day: Apples Coffee

Nancy 20 kg
Joe 10 kg

• Proposed trade: 5 coffee for 8 apples

Gains from Trade

• X: Initial production and consumption

• Y: New production • 3 extra apples for N; 1 extra coffee for J
• Z: New consumption • Simply through reallocation of hours
Gains From Trade

Proposed trade: 5 coffee for 8 apples

• The proposed price of an apple in this trade is ____ kg of coffee.

• Nancy will be to willing to trade if the price of an apple is at most ___ kg of

coffee.

• Joe will be willing to trade if the price of an apple is at least ___ kg of coffee.

• Voluntary-Trade Price Range:

• Nina can produce 3 units of coffee or 9 units of apples.
• Jaya can produce 3 units of coffee or 6 units of apples.

1. If Nina and Jaya traded with each other, who will produce (and sell) coffee?

2. What is the voluntary-trade price range for coffee?

Comparative Advantage: Summary

• Between any two agents, each has a comparative advantage in something as

long as the opportunity costs are different.

• If both items would be produced and consumed by both without trade, then
both are better off with trade.

• The voluntary trade price range for a good is determined by the range of
opportunity costs.
Increasing Opportunity Cost
• The Principle of Increasing Opportunity Cost: to increase production of
some good, always use the resource with the lowest opportunity cost. Repeat
as needed.

• Suppose Nancy and Joe are the only two workers at a farm. Who should
produce the first units of apples?

Generally when we do more of something the opportunity cost of something will tend to grow up
When we produce something we tend to use the resource with least opportunity cost
The producer with lower opportunity cost should produce more
If we only need a very few of so
as we do something the opportunity cost of something grows
Nancy and Joe as 1 Economy

• To get the joint PPF:

1. Identify the intercepts first (maximum joint production of each good)
2. Identify the point of complete specialization according to comparative
advantage.
3. Join the dots.
Nancy and Joe as 1 Economy

• The efficient way to produce 8 kg of apples:

• The efficient way to produce 34 kg of apples:

More Generally:
• Constant opportunity cost → Linear PPF
• Increasing opportunity cost → Concave PPF
Summary
Next Class