Midterm 1

# The same applies to individual producers like the

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- The same applies to individual producers (like the farmer or rancher in our book) specializing in different goods and trading with each other. E.g. Which country has the comparative advantage in computers? A: To answer this we must determine the opportunity cost of a computer in each country. The opportunity cost of a computer is: a) 10 tons of wheat in the US because producing one computer requires 100 labor hours, which instead could produce 10 tons of wheat. b) 5 tons of wheat in Japan, because producing one computer requires 125 labor hours, which instead could produce 5 tons of wheat. So Japan has a comparative advantage in computers. Lesson: Absolute advantage is not necessary for comparative advantage! TWO MEASURES OF THE COST OF A GOOD 1. Two countries can gain from trade when each specializes in the good it produces at lowest cost. Therefore, the first measure is: Absolute advantage measures the cost of a good in terms of the inputs required to produce it. 2. Another measure of cost if opportunity cost . In our example, the opportunity cost of a computer is the amount of wheat that could be produced using the labor needed to produce one computer. In our example, the opportunity cost of a computer is the amount of wheat that could be produced using the labor needed to produce one computer. THE TERMS OF TRADE - Let us say that one computer trades for 5 tons of wheat. This means that in a deal between the US and Japan, that for each computer Japan sends to US, they will send back 5 tons of wheat. - Opportunity costs within the US: 1. 1 computer = 10 tons of wheat (with the same amount of labor this is what is produced). This means that the opportunity cost of 1 ton of wheat is 1/10 of a computer. - Opportunity costs with Japan: 1. 125 Hours= 1 Computer. 25 Hours= 1 Ton of wheat 1 computer = 5 tons of wheat Therefore the opportunity cost of 1 ton of wheat is 1/5 of a computer. Therefore ...... 5W < 1C < 10W (one computer trades for between 5 tons of wheat and 10 tons of wheat) 1/10C < 1W < 1/5C This means that in the deal between the US and Japan prices will have to be set within this range. For example, the highest price the US would pay would be for 10W, because it would not make sense for the US to buy something at a price that they could produce it themselves.

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CHAPER FOUR: The Market Forces of Supply and Demand Objective: To find out how prices and quantities are determined in a market? MARKETS AND COMPETITION - A market is a group of buyers and sellers of a particular product. - A competitive market is one with m any buyers and sellers, each has a negligible effect on price. - In a perfectly competitive market: a) All goods are exactly the same (if all goods were different then the suppliers of this good would have too much power) b) Buyers and sellers are so numerous that no one can affect market price: each is a “price taker” *In this chapter we assume that markets are perfectly competitive.
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• Spring '13
• TheGlobalMaority

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