Microeconomics Questions
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2- If the economy were producing at point F,
A)
B)
C)
D)
it would not be using its resources efficiently.
it would be in a recession.
it could gain units of guns without having to sacrifice units of butter.
it would be specializing exclusively in butter production.
3-If the economy were producing at point Z and moved to point D,
A)
B)
C)
D)
it could only produce more butter at the sacrifice of some gun production.
it could only produce more guns at the sacrifice of some butter production.
it could produce more guns and more butter at the same time.
it would be impossible to produce more guns without the sacrifice of some butter production.
4-The closer we are to the production possibilities frontier and the farther away we are from the origin,
A)
the more unemployment there is.
B)
the less unemployment there is.
C)
the only way to produce more guns will be to give up some butter production.
D)
the only way to produce more butter will be to give up some gun production.
5-The opportunity cost of spending four hours at a movie theater watching a double feature the night
before a final exam would be
A)
the cost of the movie ticket.
B)
the cost of the subway fare to get to the theater.
C)
the price of the popcorn and candy bars you snuck into the theater.
D)
a higher grade on the exam.
E)
All of the choices are true.
6-Individuals are forced to make choices because
A)
wants are satiable.
B)
the supply of resources is infinite.
C)
wants are insatiable and resources are scarce.
D)
resources are insatiable.
E)
resources are satiable.
7-Gomer decides to spend an hour playing basketball rather than studying. His opportunity cost is:
A)
nothing, because he enjoys playing basketball more than studying.
B)
the increase in skill he obtains from playing basketball for that hour
C)
the missed benefit to his grades from studying for an hour
D)
nothing, because he had a free pass into the sports complex to play basketball.
8-The basic difference between macroeconomics and microeconomics is:
A)
microeconomics concentrates on individual markets while macroeconomics focuses primarily on
international trade.
B)
microeconomics concentrates on the behavior of individual consumers while macroeconomics
focuses on the behavior of firms.
C)
microeconomics concentrates on the behavior of individual consumers and firms while
macroeconomics focuses on the performance of the entire economy
D)
microeconomics explores the causes of inflation while macroeconomics focuses on the causes of
unemployment.
9-After much consideration, you have chosen Ireland over Spain for your Study Abroad program next
year. However, the deadline for your final decision is still months away and you may reverse this
decision. Which of the following events could prompt you to reverse this decision?
A)
The marginal benefit of going to Spain increases.
B)
The marginal cost of going to Spain increases.
C)
The marginal benefit of going to Ireland increases.
D)
The marginal cost of going to Ireland decreases.
10-You are considering staying in college another semester so that you can complete a major in
economics. In deciding whether or not to stay you should
A)
compare the total cost of your education to the total benefits of your education.
B)
compare the total cost of your education to the benefits of staying one more semester.
C)
compare the cost of staying one more semester to the benefits of staying one more semester.
D)
compare the total benefits of your education to the cost of staying one more semester.
11-Which of the following is an important cause of inflation in an economy?
A)
Increases in productivity in the economy
B)
The influence of positive externalities on the economy
C)
Lack of property rights in the economy
D)
Growth in the quantity of money in the economy
12- Suppose one county in Missouri decides it wants to reduce alcohol consumption, so the county
passes a law that raises the price of a bottle of beer by $1. As a result, people drive to other counties to
drink alcohol, which results in an increase in drunk driving. This illustrates the principle that people
respond to incentives.
A) True
B) False
13-Trade can make everyone better off except in the case where one person is better at doing
everything.
A) True
B) False
14-The invisible hand ensures that economic prosperity is distributed equally.
A) True
B) False
15-While the scientific method is applicable to studying natural sciences, it is not applicable to studying
a nations economy.
A) True
B) False
16-The US should not restrict employers from outsourcing work to foreign countries is a normative
statement.
A) True
B) False
17- If Shawn can produce more donuts in one day than Sue can produce in one day, then
A) Shawn has a comparative advantage in the production of donuts.
B) Sue has a comparative advantage in the production of donuts.
C) Shawn has an absolute advantage in the production of donuts.
D) Sue has an absolute advantage in the production of donuts.
18-Zora can produce 4 quilts in a week and she can produce 1 corporate website in a week. Lou can
produce 9 quilts in a week and he can produce 2 corporate websites in a week.
True or False: Zora has the comparative advantage in quilts and the absolute advantage in neither good,
while Lou has the comparative advantage in corporate websites and the absolute advantage in both
goods.
A) True
B) False
Intro to Economics
Chapter 1
Economics
Ten Principles of Economics
The study of how society manages its
scarce resources
Resources are scarce
Scarcity: the limited nature of societys
resources
Society has limited resources and
therefore cannot produce all the goods
and services people wish to have
1
2
Intro to Economics
Ten Principles of Economics
How people make decisions
Economists study:
Principle 1: People face trade-offs
Principle 2: The cost of something is what
you give up to get it
Principle 3: Rational people think at the
margin
Principle 4: People respond to incentives
How people make decisions
Work, buy, save, invest
How people interact with one another
The forces and trends that affect the
economy as a whole
Growth in average income
Fraction of the population that cannot find work
Rate at which prices are rising
3
Ten Principles of Economics
4
Ten Principles of Economics
How people interact
How the economy as a whole works
Principle 5: Trade can make everyone
better off
Principle 6: Markets are usually a good way
to organize economic activity
Principle 7: Governments can sometimes
improve market outcomes
Principle 8: A countrys standard of living
depends on its ability to produce goods and
services
Principle 9: Prices rise when the
government prints too much money
Principle 10: Society faces a short-run
trade-off between inflation and
unemployment
5
6
1
How People Make Decisions
How People Make Decisions
Principle 1: People Face Trade-offs
There aint no such thing as a free lunch
Trade-offs
Students: how to allocate time
Parents: how to spend income
To get something that we like, we usually
have to give up something else that we
also like
Society faces trade-offs:
National defense and consumer goods
(guns and butter)
Clean environment and high level of
income
Efficiency and equality
Making decisions
Requires trading off one goal against
another: to study one more hour, give up
one hour of TV
7
How People Make Decisions
8
How People Make Decisions
Efficiency
Efficiency and Equality trade-off
Society is getting the maximum benefits
from its scarce resources
The size of the economic pie
Public policies aimed at equalizing the
distribution of economic well-being
Welfare system, Unemployment insurance
Individual income tax
Equality
Achieve greater equality but reduce efficiency
Distributing economic prosperity uniformly
among the members of society
How the pie is divided into individual slices
Recognizing that people face trade-offs
Does not by itself tell us what decisions
they will or should make
9
How People Make Decisions
10
How People Make Decisions
Principle 2: The Cost of Something Is What
You Give Up to Get It
People face trade-offs; making decisions:
Principle 3: Rational People Think at the
Margin
Rational people
Compare costs with benefits of
alternatives
Need to include opportunity costs
Systematically and purposefully do the
best they can to achieve their objectives
Given the available opportunities
Opportunity cost
Marginal changes
Whatever must be given up to obtain
some item
Small incremental adjustments to a plan of
action
11
12
2
How People Make Decisions
How People Make Decisions
Why is water so cheap, while diamonds
are so expensive?
Rational decision maker
Make decisions by
comparing marginal
benefits and marginal
costs
Take action only if:
Marginal benefits > Marginal
costs
Water needed to survive
Diamonds not a necessity
A persons willingness to pay for a good
Based on the marginal benefit that an extra
unit of the good would yield
Is the marginal benefit
of this call greater than
the marginal cost?
The marginal benefit depends on how many
units a person already has
13
14
How People Make Decisions
How People Make Decisions
Seat belt law alters a drivers costbenefit
calculation (Sam Peltzman, 1975)
Principle 4: People Respond to Incentives
Incentive
Seat belts make accidents less costly
Something that induces a person to act
Higher price
(reduce the likelihood of injury or death)
Reduce the benefits of slow, careful driving
Buyers consume less; Sellers produce more
People drive faster and less carefully:
Public policy
Larger number of accidents
Change costs or benefits
Net result: little change in the number of
driver deaths and an increase in the number
of pedestrian deaths
Change peoples behavior
Can have unintended consequences
15
How People Interact
How People Interact
Principle 6: Markets Are Usually a Good Way
to Organize Economic Activity
Communist countries, central planning
Principle 5: Trade Can Make
Everyone Better Off
Trade
Allows each person to
specialize in the activities he
or she does best
Enjoy a greater variety of
goods and services
16
Government officials are in position to
allocate the economys scarce resources
For $5 a week you
can watch baseball
without being nagged
to cut the grass!
17
What goods and services were produced?
How much was produced?
Who produced and consumed these goods?
18
3
How People Interact
How People Interact
Market economy, allocation of resources
Market economies
Through decentralized decisions of many
firms and households
As they interact in markets for goods and
services
Guided by prices and self-interest
No one is looking out for the economic
well-being of society as a whole
Have proven remarkably successful in
organizing economic activity to promote
overall economic well-being
19
20
Adam Smith Would Have Loved Uber, Part 1
How People Interact
Strict controls in the market for taxis
Adam Smiths invisible hand
Regulation of insurance and safety
Limit entry into the market: limited
number of taxi medallions or permits
May determine the prices that taxis are
allowed to charge
To keep unauthorized drivers off the
streets and to prevent all drivers from
charging unauthorized prices
Households and firms interacting in
markets
As if they are guided by an invisible hand
Leads to desirable market outcomes
Corollary: Government intervention
Prevents the invisible hands ability to
coordinate the decisions that make up the
economy
21
Adam Smith Would Have Loved Uber, Part 2
22
Adam Smith Would Have Loved Uber, Part 3
Uber, launched in 2009
Not everyone is fond of Uber
App for smartphones that connects
passengers and drivers
Uber cars do not roam the streets looking
for taxi-hailing pedestrians
Traditional taxi drivers
Economists love Uber
Increase consumer well-being
Surge pricing
Not taxis; not subject to the same regulations
But they offer much the same service
Increases the quantity of car services
supplied when they are most needed
Allocate the services to those consumers
who value them most highly
Often charge less than taxis
Drivers raise their prices significantly
when there is a surge in demand
23
24
4
How People Interact
How People Interact
Principle 7: Governments Can Sometimes
Improve Market Outcomes
We need (want) government
Property rights
Ability of an individual to own and exercise
control over scarce resources
Market failure
Enforce rules and maintain institutions that
are key to a market economy
Need institutions to enforce property rights
Promote efficiency, avoid market failure
Promote equality, avoid disparities in
economic wellbeing
Situation in which the market left on its
own fails to allocate resources efficiently
Externalities
Market power
25
How People Interact
26
How People Interact
Externality
Disparities in economic wellbeing
Impact of one persons actions on the
well-being of a bystander
Pollution
Market economy rewards people
According to their ability to produce things
that other people are willing to pay for
Government intervention, public policies
Market power
Aim to achieve a more equal distribution of
Ability of an economic actor to have a
substantial influence on market prices
economic well-being
May diminish inequality
27
How Economy as a Whole Works
28
How Economy as a Whole Works
Principle 8: A Countrys Standard of Living
Depends on Its Ability to Produce Goods and
Services
Large differences in living standards
Explanation: differences in productivity
Productivity
Quantity of goods and services produced
from each unit of labor input
Higher productivity
Among countries:
Average annual income, 2014: $55,000 (U.S.);
Higher standard of living
$17,000 (Mexico); $13,000 (China); $6,000
(Nigeria)
Growth rate of nations productivity
Determines growth rate of its average income
Over time: In the U.S. incomes have
historically grown about 2% per year
29
30
5
How Economy as a Whole Works
How Economy as a Whole Works
Principle 9: Prices Rise When
the Government Prints Too
Much Money
Inflation
Principle 10: Society Faces a Short-Run
Trade-off between Inflation and
Unemployment
Short-run effects of monetary injections:
An increase in the overall
level of prices in the economy
Causes for large or persistent
inflation
Growth in quantity of money
Value of money falls
Well it may have been
68 cents when you got in
line, but its 74 cents
now!
Stimulates the overall level of spending
and demand
Firms raise prices, hire more workers,
produce more goods
Lower unemployment
31
32
Table 1 Ten Principles of Economics
How Economy as a Whole Works
How People Make Decisions
1: People Face Trade-offs
2: The Cost of Something Is What You Give Up to Get It
3: Rational People Think at the Margin
4: People Respond to Incentives
Short-run trade-off between
unemployment and inflation
Over a period of a year or two, many
economic policies push inflation and
unemployment in opposite directions
How People Interact
5: Trade Can Make Everyone Better Off
6: Markets Are Usually a Good Way to Organize Economic Activity
7: Governments Can Sometimes Improve Market Outcomes
Business cycle
How the Economy as a Whole Works
8: A Countrys Standard of Living Depends on Its Ability to Produce Goods and Services
9: Prices Rise When the Government Prints Too Much Money
10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
Fluctuations in economic activity
Such as employment and production
33
34
6
The Economist as a Scientist
Chapter 2
Economics is a science
Economists are scientists
Thinking Like an Economist
Devise theories
Collect data
Analyze these data
Verify or refute their
theories
Use the scientific method
Im a social scientist,
Michael. That means I
cant explain electricity
or anything like that, but
if you ever want to know
about people, Im your
man.
1
.
2
The Economist as a Scientist
The Economist as a Scientist
Scientific method
The role of assumptions
Assumptions
Dispassionate development and testing of
theories about how the world works
Observation, theory, more observation
Can simplify the complex world and make
it easier to understand
The art in scientific thinking: deciding
which assumptions to make
Conducting experiments in economics
Is often impractical
Different assumptions
Substitute for laboratory experiments
To answer different questions
To study short-run or long-run effects
Economists pay close attention to the
natural experiments offered by history
3
The Economist as a Scientist
4
The Economist as a Scientist
Circular-flow diagram
Economic models
Visual model of the economy
Shows how dollars flow through markets
among households and firms
Diagrams and equations
Omit many details
Allow us to see whats truly important
Built with assumptions
Simplify reality to improve our
understanding of it
Two decision makers
Firms and Households
Two markets
For goods and services
For factors of production (inputs)
5
6
1
Figure 1 The Circular Flow
The Economist as a Scientist
This is a schematic
representation of the economy
Production possibilities frontier
All decisions are made by
households and firms
A graph
Combinations of output that the economy
can possibly produce
Given the available
In the markets for goods and
services, households are
buyers and firms are sellers
In the markets for the factors
of production, firms are buyers
and households are sellers
Factors of production
Outer arrows show the flow of
dollars
Production technology
Inner arrows show the flow of
inputs and outputs
8
7
Figure 2 – The Production Possibilities Frontier
The Economist as a Scientist
The PPF shows the
combinations of output (cars
and computers) that the
economy can produce
Efficient levels of production
The economy is getting all it can from the
scarce resources available
Points on the production possibilities
frontier
Trade-off:
The economy can produce
any combination on or inside
the frontier
Points outside the frontier are
not feasible
The slope of the PPF is the
opportunity cost of a car in
terms of computers. This
opportunity cost varies,
depending on how much of
the two goods the economy is
producing.
The only way to produce more of one good is
to produce less of the other good
Moving from point A to point B: give up 200
computers to produce 100 more cars
10
9
The Economist as a Scientist
The Economist as a Scientist
Bowed outward production possibilities
frontier
Inefficient levels of production
Points inside production possibilities
frontier
Opportunity cost of a car is highest
When the economy is producing many cars
Opportunity cost of producing one good
and fewer computers
Give up producing units of the other good
Slope of the production possibilities
frontier
Opportunity cost of a car is lower
When the economy is producing fewer cars
and many computers
11
12
2
Figure 3 – A Shift in the Production Possibilities Frontier
The Economist as a Scientist
Technological advance
A technological advance in
the computer industry
enables the economy to
produce more computers
for any given number of
cars
Outward shift of the production
possibilities frontier
Economic growth
Produce more of both goods
PPF shifts outward
If the economy moves
from point A to point G,
then the production of both
cars and computers
increases
13
The Economist as a Scientist
14
The Economist as Policy Adviser
Positive statements: descriptive
Microeconomics
Attempt to describe the world as it is
Confirm or refute by examining evidence:
Minimum-wage laws cause
unemployment
The study of how households and firms
make decisions and how they interact in
markets
Macroeconomics
Normative statements: prescriptive
The study of economy-wide phenomena,
including inflation, unemployment, and
economic growth
Attempt to prescribe how the world should
be: The government should raise the
minimum wage
15
16
Why Economists Disagree
The Economist as Policy Adviser
Economists advice is not always followed
Economic advisers: what policy is best
Communication advisers: how best to explain
it to the public
Press advisers: how the news media will
report
Legislative affairs advisers: how Congress
will view the proposal
Political advisers: effect on the electorate
The president: decision
17
Economists may disagree
Validity of alternative positive theories
about how the world works
Economists may have different values
Different normative views about what
policy should try to accomplish
18
3
ASK THE EXPERTS
Why Economists Disagree
Ticket Resale
Differences in values
Jack and Jill take the same amount of
water from the town well
Laws that limit the resale of tickets for
entertainment and sports events make
potential audience members for those events
worse off on average.
Jill’s income = $150,000
Tax = $15,000 (10%)
Jacks income = $40,000
Tax = $6,000 (20%)
19
Table 1
.
20
Table 1
Propositions about Which Most Economists Agree
Proposition (and percentage of economists who agree)
1. A ceiling on rents reduces the quantity and quality of housing available. (93%)
2. Tariffs and import quotas usually reduce general economic welfare. (93%)
3. Flexible and floating exchange rates offer an effective international monetary
arrangement. (90%)
4. Fiscal policy (for example, tax cut and/or government expenditure increase) has
a significant stimulative impact on a less than fully employed economy. (90%)
5. The United States should not restrict employers from outsourcing work to foreign
countries. (90%)
6. Economic growth in developed countries like the United States leads to greater
levels of well-being. (88%)
7. The United States should eliminate agricultural subsidies. (85%)
8. An appropriately designed fiscal policy can increase the long-run rate of capital
formation. (85%)
9. Local and state governments should eliminate subsidies to professional sports
franchises. (85%)
10. If the federal budget is to be balanced, it should be done over the business cycle
rather than yearly. (85%)
21
Propositions about Which Most Economists Agree
11. The gap between Social Security funds and expenditures will become
unsustainably large within the next 50 years if current policies remain
unchanged. (85%)
12. Cash payments increase the welfare of recipients to a greater degree than do
transfers-in kind of equal cash value. (84%)
13. A large federal budget deficit has an adverse effect on the economy. (83%)
14. The redistribution of income in the United States is a legitimate role for the
government.(83%)
15. Inflation is caused primarily by too much growth in the money supply. (83%)
16. The United States should not ban genetically modified crops. (82%)
17. A minimum wage increases unemployment among young and unskilled workers.
(79%)
18. The government should restructure the welfare system along the lines of a
negative income tax. (79%)
19. Effluent taxes and marketable pollution permits represent a better approach to
pollution control than the imposition of pollution ceilings. (78%)
20. Government subsidies on ethanol in the United States should be reduced or
eliminated. (78%)
22
4
Figure A-1 Types of Graphs
Graphing: A Brief Review
Graphs serve two purposes:
Visually express ideas that might be less
clear if described with equations or words
Powerful way of finding and interpreting
patterns
Graphs of a single variable
Pie chart
Bar graph
Time-series graph
2
1
Figure A-2 Using the Coordinate System
Graphing: A Brief Review
Graphs of two variables: the coordinate
system
Display two variables on a single graph
Scatterplot
Ordered pairs of points
x-coordinate
Horizontal location
y-coordinate
Grade point average is measured on the vertical axis and study time on the horizontal axis.
Albert E., Alfred E., and their classmates are represented by various points.
We can see from the graph that students who study more tend to get higher grades.
Vertical location
4
3
Table A-1 Novels Purchased by Emma
Graphing: A Brief Review
Price For $30,000
Income:
Curves in the coordinate system
Data
$10 2 novels
Number of novels purchased
Price of novels and Income
Demand curve
For $40,000
Income:
For $50,000
Income:
5 novels
8 novels
9 6
9
12
8 10
13
16
7 14
17
20
6 18
21
24
5 22
25
28
Demand curve, D3 Demand curve, D1 Demand curve, D2
Effect of a goods price
On the quantity of the good consumers
want to buy
For a given income
This table shows the number of novels Emma buys at various incomes and prices.
For any given level of income, the data on price and quantity demanded can be graphed to
produce Emmas demand curve for novels, as shown in Figures A-3 and A-4.
5
6
1
Figure A-3 Demand Curve
Graphing: A Brief Review
Negatively related variables
The two variables move in opposite direction
Downward sloping curve
Positively related variables
The two variables move in the same direction
Upward sloping curve
Movement along a curve
Shifts in a curve
The line D1 shows how Emmas purchases of novels depend on the price of novels when her
income is held constant. Because the price and the quantity demanded are negatively related,
the demand curve slopes downward.
8
7
Figure A-4 Shifting Demand Curves
Graphing: A Brief Review
Slope
Ratio of the vertical distance covered to
the horizontal distance covered
As we move along the line
? (delta) = change
The rise (change in y) divided by the run
(change in x).
The location of Emmas demand curve for novels depends on how much income she earns.
The more she earns, the more novels she will purchase at any given price, and the farther to
the right her demand curve will lie. Curve D1 represents Emmas original demand curve when
her income is $40,000 per year.
If her income rises to $50,000 per year, her demand curve shifts to D2.
If her income falls to $30,000 per year, her demand curve shifts to D3.
Slope ?
?y
?x
9
10
Figure A-5 – Calculating the Slope of a Line
Graphing: A Brief Review
Slope
Fairly flat upward-sloping line
Slope is a small positive number
Steep upward-sloping line
Slope is a large positive number
Downward sloping line
Slope is a negative number
Horizontal line: slope is zero
Vertical line: infinite slope
To calculate the slope of the demand curve, we can look at the changes in the x- and ycoordinates as we move from the point (21 novels, $6) to the point (13 novels, $8). The slope
of the line is the ratio of the change in the y-coordinate (2) to the change in the x-coordinate
(+8), which equals 1 4.
11
12
2
Figure A-6 – Graph with an Omitted Variable
Graphing: A Brief Review
Cause and effect
One set of events
Causes another set of events
Omitted variables
Lead to a deceptive graph
The upward-sloping curve shows that members of households with more cigarette
lighters are more likely to develop cancer. Yet we should not conclude that ownership
of lighters causes cancer because the graph does not take into account the number of
cigarettes smoked.
13
14
Graphing: A Brief Review
Causality vs. Correlation
15
3
A Parable for the Modern Economy
Chapter 3
Only two goods
Interdependence and the Gains from Trade
Meat
Potatoes
Only two people
A cattle rancher named Ruby
A potato farmer named Frank
Both would like to eat both meat and
potatoes
1
2
Figure 1 – The Production Possibilities Frontier
A Parable for the Modern Economy
If Ruby produces only meat and Frank
produces only potatoes
Both gain from trade
If both Ruby and Frank produce both
meat and potatoes
Empty cell
Minutes needed
to make 1 ounce
of meat
Minutes needed
to make 1 ounce
of potatoes
Amount of meat
produced in 8
hours
Amount of
potatoes
produced in 8
hours
Frank the farmer
60 minutes per
ounce
15 minutes per
ounce
8 ounces
32 ounces
Ruby the rancher
20 minutes per
ounce
10 minutes per
ounce
24 ounces
48 ounces
Panel (a) shows the production opportunities available to Frank the farmer and Ruby the
rancher.
Both gain from specialization and trade
Production possibilities frontier
Various mixes of output that an economy
can produce
3
Figure 1 – The Production Possibilities Frontier
(b) Franks production
possibilities frontier
4
A Parable for the Modern Economy
(c) Rubys production
possibilities frontier
Specialization and trade
Farmer Frank specializes in growing
potatoes
More time growing potatoes
Less time raising cattle
Rancher Ruby specializes in raising cattle
More time raising cattle
Panel (b) shows the combinations of meat and potatoes that Frank can produce.
Panel (c) shows the combinations of meat and potatoes that Ruby can produce.
Both production possibilities frontiers are derived assuming that Frank and Ruby each work 8
hours per day. If there is no trade, each persons production possibilities frontier is also his or
her consumption possibilities frontier.
Less time growing potatoes
Trade: 5 oz of meat for 15 oz of potatoes
5
6
1
Figure 2 – How Trade Expands the Set of Consumption Opportunities
(a) Franks production
and consumption
Figure 2 – How Trade Expands the Set of Consumption Opportunities
(b) Rubys production
and consumption
Empty cell
Franks meat Franks potat
oes
Production and consu 4 ounces
16 ounces
mption without trade
Production with trade 0 ounce
32 ounces
Trade
Gets 5 ounces Gives 15 oun
ces
Consumption with tra 5 ounces
17 ounces
de
Increase in consumpt Increase of 1 o Increase of 1
ion with gains from tr unce
ounce
ade
Rubys meat
Rubys potatoes
12 ounces
24 ounces
18 ounces
12 ounces
Gives 5 ounces Gets 15 ounces
13 ounces
27 ounces
Increase of 1 ou Increase of 3 ou
nce
nces
The proposed trade between Frank the farmer and Ruby the rancher offers each of them a
combination of meat and potatoes that would be impossible in the absence of trade.
In panel (a), Frank gets to consume at point A* rather than point A.
In panel (b), Ruby gets to consume at point B* rather than point B. Trade allows each to
consume more meat and more potatoes.
7
8
Comparative Advantage
Comparative Advantage
Absolute advantage
Opportunity cost
The ability to produce a good using fewer
inputs than another producer
Whatever must be given up to obtain
some item
Measures the trade-off between the two
goods that each producer faces
In producing meat: Ruby
Ruby needs 20 min. to produce 1 oz of meat
Frank needs 60 minutes
In producing potatoes: Ruby
Ruby needs 10 min. to produce 1 oz of
potatoes
Frank needs 15 minutes
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10
Table 1 – The Opportunity Cost of Meat and Potatoes
Comparative Advantage
Opportunity cost
Frank: 60 min. to produce 1 oz meat, and 15
min. to produce 1 oz potatoes
To produce 1 more oz meat, give up 4 oz potatoes
To produce 1 more oz potatoes, give up ¼ oz meat
Ruby: 20 min. to produce 1 oz meat, and 10
min. to produce 1 oz potatoes
Empty cell
Opportunity cost of 1
ounce of meat
Opportunity cost of 1
ounce of potatoes
Frank the farmer
4 ounces of potatoes
One-quarter ounce of
meat
Ruby the rancher
2 ounces of potatoes
One-half ounce of meat
To produce 1 more oz meat, give up 2 oz potatoes
To produce 1 more oz potatoes, give up ½ oz meat
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12
2
Comparative Advantage
Comparative Advantage
Comparative advantage
One person
The ability to produce a good at a lower
opportunity cost than another producer
Reflects the relative opportunity cost
Can have absolute advantage in both goods
Cannot have comparative advantage in both
goods
Principle of comparative advantage
For different opportunity costs
Each good should be produced by the individual that
has the smaller opportunity cost of producing that
good
One person has comparative advantage in
one good
The other person has comparative
advantage in the other good
Specialize according to com
