Lecture_2_handout - EC1301 Principles of Economics Lecture...

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1 EC1301 Principles of Economics Lecture 2 Exchange and the Market Model Textbook, Chapters 3 and 4
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2 Agenda 1. Basis for Exchange Comparative Advantage Specialization and Gains from Trade/Exchange 2. Economic System Role of Government 3. The Demand and Supply Model The Demand Curve The Supply Curve Market Equilibrium Changes to Market Equilibrium
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3 Production Possibilities and Cost of Production Consider Crusoe on an island. Each day, he has 8 daylight hours to gather coconuts and to catch fish Being self-sufficient , he consumes what he produces Hours per day Output Per Day gathering coconuts Coconuts Fish 0 02 4 2 21 8 4 41 2 6 66 8 80 Cost of Producing Coconuts = 3 Fish per Coconut Coconuts Fish 8 Assume:
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4 Production Possibilities and Cost of Production Friday works and lives on the other side of the island. Each day, he works only 6 hours gathering coconuts and catching fish. His productivity is as follows: Being self-sufficient , he produces and consumes Hours per day Output Per Day gathering coconuts Coconuts Fish 0 06 2 24 4 42 6 60 Cost per Coconut = 1 Fish Coconuts Fish Assume:
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5 Comparative Advantage Cost of Coconut Production –For Crusoe, 3 Fish –For Friday, 1 Fish Friday has the comparative advantage in Coconut Cost of Fish Production Who has the comparative advantage in Fish? comparative advantage The ability of one person or nation to produce a good at a lower opportunity cost than the other person or nation. 1 For Crusoe, Coconut 3 For Friday, 1 Coconut
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6 Basis for Exchange: Comparative Advantage Specialization and the Gains from Trade –T h e r e i s a rate of exchange between the two goods such that if each specializes in producing the good it has the comparative advantage in and exchanges it for the other good, then both individuals end up better off 0 5 10 15 20 25 30 0123456789 Number of Coconut per day Number of Fish per day Crusoe’s PPC Friday’s PPC Slope of PPC = Cost of Coconut Production
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7 Specialization and Gains from Trade Through specialization and trade, each ends up with one more coconut and one more fish. Quantity per day Coconut Fish Coconut Fish Crusoe Production 0 24 Exchange 3 -5 Consumption 3 19 2 18 Friday Production 6 0 Exchange -3 5 Consumption 3 5 2 4 Specialization & Trade Before
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8 Specialization and Gains from Trade Specialization allows costs to be minimized. Output is increased when we all focus on those tasks in which we are relatively more productive. Private property rights Allows freedom to exchange Provides incentives for individuals to specialize in the activities of their comparative advantage
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9 Comparative Advantage and International Trade import A product produced in a foreign country and purchased by residents of the home country.
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This note was uploaded on 03/19/2012 for the course ARTS EC1301 taught by Professor Forgot during the Fall '08 term at National University of Singapore.

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Lecture_2_handout - EC1301 Principles of Economics Lecture...

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