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The saga of North Potato. Residents of the isolated country of North Potato subsist entirely on potatoes and fish. There are 1000 farmers in North Potato. 900 of these farmers have land that is dry and not very fertile. 100 of them have more fertile soil.
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Residents of the isolated country of North Potato subsist entirely on potatoes and fish. • There are 1000 farmers in North Potato. • 900 of these farmers have land that is dry and not very fertile. • 100 of them have more fertile soil.
The 900 farmers with poor soil work 60 hours a week, either growing yams or catching fish. It takes a worker 3 hours to produce a unit of yams and 1 hour to produce a unit of fish. The production possibility set for one of these farmers consists of combinations of yams Y and fish F that lie on or below the line with equation • 3Y+F= 60 • Y/3+F=60 • Y+3F=60 • Y+F/3=60
If it takes him three times as long to produce a unit of yams as a unit of fish if a farmer does not trade with others, what is his tradeoff between yams and fish. • A unit of yams costs three times as much as a unit of fish • A unit of fish costs three times as much as a unit of yams.
The fertile farms • The island has 100 more fertile farms. Farmers on these farms can produce one unit of yams per hour spent farming or they can catch one fish for every hour they spend fishing. They spend 60 hours per week either fishing or farming.
What equation describes combinations of fish F and yams Y that a fertile farm can produce in a week? • C+F=60 • C+F/3=60 • F+C/2=60
Comparative advantage in N.P. • Farmers with poor land can produce 1/3 of a unit of yams per hour and 1 unit of fish per hour. • Farmers with rich land can produce 1 unit of yams and 1 unit of fish per hour. • Who has comparative advantage in yams? • Who has comparative advantage in fish?
What if everybody specialized according to comparative advantage? • Farmers with poor land would produce fish only. • Farmers with rich land would produce yams only. • What would output be? 900 poor land farmers would each produce 60 fish. • Total fish =60x900=54,000 • 100 rich land farmers would each produce 60 units of yams. • Total yams =60x100=6,000
Consumption in North Potato • Residents of North Potato find it essential to their diets that they each consume equal quantities of fish and yams • So if both types of farmers specialized according to comparative advantage, there would be too many fish (54,000) and not enough yams (6,000) • What has to happen?
Efficiency demands that poor land farmers produce some yams and some fish while rich land farms specialize in yams. To induce poor land farmers to do this, we need unit price of yams to be 3 times the price of fish.
Farmers with good land can produce one unit of yams or one unit of fishper hour. If the price of yams is 3 times the price of fish, what will they do? • Produce only yams, • Produce only fish, • Produce some of each
Rich land farmers specialize in yams, produce 60 yams and no fish. They trade yams for fish at price of 3 fish per yam. If they sell 15 yams, they will have 45 yams and 60-15=45 fish.
What do poor land farmers do • When yams cost 3 times as much as fish, poor land farmers are just indifferent between specializing in fish and trading in the market or producing some fish and some yams. Unlike the rich land farmers, they don’t gain (or lose) by specializing. But they do need to either trade or diversify to equalize yams and fish. Best they can do is spend 15 hours fishing and 45 hours growing yams. Then they get 15 units of each good.
Suppose that in the rest of the world, outside of North Potato, yams trade for slightly more than one yam per fish. What would happen if North Potato opened up to trade?
Price of yams would fall to about one fish per yam. • Who would benefit? • Poor land farmers, Why? • Now they can specialize in fish, and buy their yams for one fish per yam rather than 3 fish per yam • Who would lose? • Rich land farmers, Why? • They can no longer get 3 fish per yam, since poor land farmers can buy them abroad at 1 fish per yam.
With world trade, and prices of one fish per yam, poor land farmers can specialize in fish, buy yams for one fish and consume 30 fish and 30 yams. Without free trade, prices of yams were 3 fish and they could onlyconsume 15 fish and 15 yams.Poor land famers gain.
What about rich land farmers? • Before international trade, they specialized in yams and sold yams at a price of 3 fish per yam. • They were able to consume 45 units of fish and 45 units of yams. • Now price of yams falls to 1 fish. • They are now indifferent between specializing in yams or spending some time in each activity. • Either way they can only get 30 fish and 30 yams. • They are worse off.
Free trade doesn’t always benefit everybody • Typical argument: Rich land farmers would complain that “Unfair competition is ruining our way of life”. Taking the profit out of agriculture. • They do not experience the benefits of trade.
Comparing gains and losses • Without world trade, 100 rich land farmers were able to consume 45 yams and 45 fish, while 900 poor land farmers could consume only 15 yams and 15 fish. • With world trade, all 1000 residents consume 30 yams and 30 fish. • Total gains of winners exceed total losses of losers. • Could winners “buy off” losers to get free world trade adopted?
