Universität Leipzig Introduction to Economics Lecture 2: Digression Alexander Fink, PhD

1. Universität LeipzigIntroduction to EconomicsLecture 2:DigressionAlexander Fink, PhD

2. A Factor that Does Not Explain the Crises of the Years Past I • Greed Bankers were greedy in the medieval ages Bankers were greedy in the 1980s Bankers are greedy today Bankers were greedy in the 19th century

3. A Factor that Does Not Explain the Crises of the Years Past II • More greedy people

4. Universität LeipzigIntroduction to EconomicsLecture 2:Exchange and SpecializationAlexander Fink, PhD

5. Interdependence and the Gains from Trade • Why is interdependence the norm? • Interdependence occurs because people are better off when they specialize and trade with others. • What determines the pattern of production and trade? • Patterns of production and trade are based upon differences in opportunity costs.

6. Production Possibilities of a Farmer and a Rancher

7. 24 If there is no trade, the rancher chooses this production and consumption. If there is no trade, the farmer chooses this production and B 8 12 consumption. A 4 16 32 24 48 The Production Possibility Frontier The Farmer The Rancher Meat Meat 0 0 Potatoes Potatoes

8. Production Without Trade • Self-Sufficiency • By ignoring each other: • Each consumes what they each produce. • The production possibilities frontier is also the consumption possibilities frontier.

9. Cost, Production, and Trade • Differences in the costs of production determine the following: • Who produces what? • How much is traded for each product? Who can produce potatoes at a lower cost--the farmer or the rancher?

10. Absolute Advantage • The comparison among producers of a good according to their productivity—absolute advantage • Describes the productivity of one person or firm compared to that of another. • The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.

11. Absolute Advantage • The Rancher needs only 10 minutes to produce a unit of potatoes, whereas the Farmer needs 15 minutes. • The Rancher needs only 20 minutes to produce a unit of meat, whereas the Farmer needs 60 minutes. The Rancher has an absolute advantage in the production of both meat and potatoes.

12. Opportunity Cost and Comparative Advantage • Compares producers of a good according to their opportunity cost. • Whatever must be given up to obtain some item (the highest valued alternative forgone) • The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

13. Comparative Advantage and Trade • Who has the comparative advantage? • The farmer or the rancher?

14. 24 Slope: -1/4 Slope: -1/2 8 32 48 Opportunity Cost The Farmer The Rancher Meat Meat 0 Potatoes 0 Potatoes

15. Comparative Advantage and Trade …so, the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes.

16. Feasible Production With Trade

17. Rancher's 24 production with trade Rancher's consumption 18 with trade Farmer's 13 consumption B* Rancher's with trade Farmer's 8 production and B production and 12 consumption consumption without trade A* without trade 5 4 A Farmer's production with trade 32 12 24 27 48 16 17 Expansion of Consumption Possibilities Through Trade The Farmer The Rancher Meat Meat 0 0 Potatoes Potatoes

18. Consumption and Production With Trade We specialize when we produce more of a good or service than we consume.

19. Gains of Trade: A Summary

20. Comparative Advantage and Trade • Comparative advantage and differences in opportunity costs are the basis for specialized production and trade. • Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.

21. What Can We Say About the Exchange Ratio? • Farmer gives 3 unit of potatoes for 1 unit of meat • His opportunity cost of producing 1 unit of meat is 4 units of potatoes • Rancher gives 1/3 unit of meat for 1 unit of potatoes • His opportunity cost of producing 1 unit of potatoes is ½ unit of meat

22. What Can We Say About the Exchange Ratio? • The exchange ratio will be between • Or: • More on the emergence of prices next lecture 1 1 units of meat > > units of potatoes 2 4 units of potatoes 4 > > 2 units of meat

23. Exchange and Specialization • Specialize in production • Diversify in consumption • Division of labor is limited my the extent of the market • Social cooperation under the division of labor

24. Knowledge Economy? • Or rather an Un-Knowledge Economy? • “Civilization advances by extending the number of important operations which we can perform without thinking about them.” • Alfred North Whitehead

25. Two Worlds • Interaction in small groups • Interaction in the large open society

26. Literatur • Read, Leonard E. 1958. I, Pencil. • http://www.commonsenseeconomics.com/Readings/I.Pencil2006.FEE.pdf?nid=316