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shows the maximum output that can be achieved using all the resources at hand.

Now let us assume that we are talking of the PPF of a country.

:. the PPF will show the max amount of goods that the country can have.

If the country , ie the people living in the country or in the economy, wish to
consume more goods than they are producing - what options do they have?

1.Economic Growth ( is achieved either because the economy has discovered

new and better , more efficient production technologies, or because the
economy has more resources available).

2. TRADING ….we exchange our surpluses for the surpluses of other countries/
economies/individuals. BARTER system …involved the direct exchange of
surpluses. Today the Barter system has been superseded as money has been
introduced as a generally accepted form of payment for any transactions. Money
is a CLAIM on wealth that facilitates transactions.

So now, our aim to to analyse the terms on which countries would be willing to
trade with one another.
We speak of 2 laws:
The Law of Absolute Advantage
The Law of Comparative Advantage

ASSUMPTIONS:
1. we assume there are only 2 countries, each able to produce only the same 2
goods.
2. we assume that the 2 economies have identical resources
3. resources are transferrable from the production of one good to that of the
other
4. we assume that resources are divisible.

When we say that resources are divisible we mean that instead of using the full
resource to produce an output , we can use only part of the resrouce to produce
one good and transfer the remained to produce a different good.

1 man produces a table

divide this
0.5 man produce a table and 0.5 man will produce a meal in a restaurant
Assumptions are useful because they help us simplify an otherwise very complicated
reality in social science.

The law of ABSOLUTE ADVANTAGE - coined by ADAM SMITH

ADAM SMITH is the FATHER OF MODERN ECONOMICS - SCOTTISH
WE refer to him as the point at which CLASSICAL ECONOMICS started.
Adam Smith believed in the free operation of the market - the market mechanism

Pizza Crepes
Italy 200 or 200

France 50 or 300

Here we have a very clear cut situation - a very neat situation.

Italy is better in the production of pizzas - Italy must specialise in pizza

France is better in the production of crepes - must specialise in crepes

After Specialisation self sufficiency

means that you can produce all the
goods that you need
Pizza Crepes
Pizza Crepes
Italy 200 and 0
Italy 100 and 100
France 0 and 300
- France 25 and 150
Total world output 200 and 300
Total world 125 and 250
This proves that specialisation gives a output
larger output than self sufficiency.
This is because of a more efficient use of remember with self sufficiency you
resources. produce exactly what you need - any
more or any less.
 the solution for someone in Italy to enjoy both pizza and crepes (and vice versa for
someone in France) is to TRADE!!!!

How will they trade:

Pizza Crepes

ft
Italy 200 and 0

+23£
100
France 0 and 300
-

After trade

Pizza and Crepes

Italy 175 and 100

France 25 and 200

Result:
1. both countries are satisfying their needs ( as per self sufficiency table)
2. resources are used more efficiently as more of both goods is being produced
as a result of specialisation.

Trade has taken place

If trade has taken place, a price must have been established:

Italy exchanged 25 pizzas for 100 crepes

I
:. the prices of 1 pizza was 100/25 crepes : 1 pizza = 4 crepes

France exchanged 100 crepes for 25 pizzas

:. the price of 1 crepes is 25/100 pizza = 1 crepes is worth 0.25 pizza

Determining the international price.

等 产量曲线