Mankiw: Chap 3 Gains from specialization and trade production possibility frontiers absolute advantage comparative adv

1. Mankiw: Chap 3 • Gains from specialization and trade • production possibility frontiers • absolute advantage • comparative advantage • consumption possibilities without trade • consumption possibilities with trade • specialization

2. Main lessons from Chap 3 • Specialization expands ________________ hence trade is good for society • Specialization and trade is good even for countries _________________________ ____________________________ • ________facilitate specialization and trade

3. Tom and Jerry can work 8 hrs per day (40 hrs a week) • Production possibilities

4. 2. Production possibility frontiers meat (oz.) meat (oz.) Tom Jerry potatoes (oz.) potatoes (oz.) What happens to Tom’s PPF if he works for 48 hours a week?

5. Opportunity cost of an oz. of potatoes in terms of meat • = • = of the production possibility frontier • What is the opportunity cost of producing an oz. of potatoes for Tom? • For Jerry • What is the opportunity cost of producing meat for Tom? • For Jerry? • Tom has ______________ in potatoes and Jerry has _______ in meat. • Comparative advantage comes from differing ____________

6. Jerry has _________________ in the production of both. • Why? • examples of developing and developed countries • Aside (not important for exams) • Production possibility frontiers can be linear or a curve. • It is linear when • It is a curve when

7. 3.Consumption possibility frontiers without trade meat meat Tom consumes A if he divides his time ½ and ½ Jerry consumes B if he divides his time ½ and ½ potatoes potatoes

8. Suppose they decide to trade. • A central planner decides (arbitrarily) that the price is 3 oz. of potatoes for 1 oz. of potatoes. • Tom spends • Jerry spends • Jerry trades • Tom consumes • Jerry consumes • Outcome?

9. 4. Consumption possibility with trade meat meat Tom Jerry potatoes potatoes

10. Asides: • Outcome of trade - Both can consume outside their production frontier • Prices are arbitrarily chosen by the central planner here. • In real economies they are determined by market forces (Chap 4). • How Tom and Jerry divide their time (degree of specialization) between the production of meat and potatoes depend on the prices – • This is a case of incomplete specialization -

11. 5. Relationship between trading prices, comparative advantages and specialization • Tom’s opportunity cost: • Jerry’s opportunity cost: • Arbitrarily chosen trading prices: • Conclusions: • So long as trading prices are • Each _________ the product they have a _________________in and _________ the other.