Where does your stuff come from?

Why have your clothes and personal items traveled all around the world?

Why People Trade1. Suppose you couldn’t trade with anyone.

What things would you have to give up? Everything you don’t make yourself!

(Clothes, phones, bananas, heath care, etc)

2. Suppose you could only buy things that were produced in Arizona.

Stopping trade would reduce people’s choices and make them worse off. Trade provides more choices =>

higher standard of living.

2

Absolute and Comparative Advantage

3

Suppose that you have the skills to be both an excellent fast food cook and an outstanding heart surgeonYour neighbor, Ronald, is less talented: he could be a mediocre fast food cook, but would make a terrible heart surgeonYou have an absolute advantage over Ronald as a fast food cookYou also have an absolute advantage over him as a heart surgeon

Homework Review

1.A. What term is used to describe the fundamental problem of economics?

Scarcity!

1.B. Define scarcity

Humans have unlimited wants but limited resources with which to satisfy them

2. What does it mean to “think at the margin”? Give an example.

Comparing the costs and benefits of one more unit of something Is one more slice of pecan pie worth the cost?

3. What is the difference between a positive and normative statement? Give an example of each.

Positive – just factsNormative – opinion/ value judgmentPositive – Barack Obama is the PresidentNormative – Barack Obama is the best president ever!

4. What is the difference between economic costs (costs according to an economist) and accounting costs (costs according to an accountant)?

Accounting costs – out-of-pocket costs (explicit costs) onlyEconomic costs – out-of-pocket costs AND opportunity costs (implicit costs)

5. List the four factors of production. Define each.

Land – any natural resourcesLabor – human effort used to produce goods and servicesCapital

Physical – man-made resources (e.g. machines, tools, equipment)

Human – education, knowledge, and trainingEntrepreneurship – the act of combining land, labor and capital to make goods and services people want

6. Give an example of a good.

Pecan Pie!

7. Give an example of a service.

A massage

8. What points on the graph are productively efficient?

A through D

9. What is the opportunity cost of moving from combination D to combination B?

6 Twix Bars

10. What is the opportunity cost of moving from combination C to combination D?

6 Snickers Bars

11. What is the opportunity cost of moving from combination A to combination B?

2 Snickers Bars

12. What is true about point E?

It’s inefficient!

13. What is true about point G?

It’s impossible!

14. Assume that everyone in this economy despises Snickers bars but loves Twix bars. Which point(s) is/are allocatively efficient?

D!

1.Do NOT open your bag yet!2.At the END of the class period,

whatever is in your bag will be yours to keep.

3.Now, open your bag4.Rate your satisfaction with the

contents of your bag on a scale from 1 to 10 (1 being disgusted, 10 being elated)

5.Let’s add up our ratings

Experiment

1.Now, with ONLY YOUR TABLEMATE, you may trade some or all of the contents of your bag. You are NOT required to trade if you don’t want to.

2.Rate your satisfaction again.3.Let’s add up our ratings.

Round 1

1.Now, with ONLY THE PEOPLE IN YOUR ROW, you may trade some or all of the contents of your bag. You are NOT required to trade if you don’t want to.

2.Rate your satisfaction again.3.Let’s add up our ratings.

Round 2

1.Now, you may trade with anyone else in the class!

2.Rate your satisfaction again.3.Let’s add up our ratings.

Round 3

Debrief1.How many people made trades?2.Did anyone not trade?3.How many people traded more

than once?4.We had exactly as much candy in

the classroom before and after the experiment. Why did our average satisfaction increase with each new round?

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To become a cook, you must give up a far more lucrative career as a heart surgeon – your opportunity cost is very highRonald, however, has a lower opportunity cost – to become a cook, he only has to give up a career as a parking attendantTherefore, Ronald has a comparative advantage in fast food cooking... even though you would be a better cook than him

Which career should you choose?

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Absolute advantage: the ability of an individual or group to do something better or more efficiently than another individual or group.Comparative advantage: the ability of an individual or group to do something at a lower opportunity cost than another individual or groupThe law of comparative advantage says that if people specialize in the activities in which they have the lowest opportunity cost – then everyone will be better off

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• Comparative and absolute advantage apply to countries!

• Climate, geography, the skills and size of its labor force, etc. – make a country good at producing some things and bad at others

• Countries have to make choices about what to produce

• To be efficient, they should produce those goods and services

in which they have a comparative advantage

Benefits of Specialization and

Trade

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International Trade

Su

gar

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ns)

Su

gar

(to

ns)

45

40

35

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25

20

15

10

5

0

30

25

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15 10 5

05 10 15 20 25 30 5 10 15 20

Wheat (tons) Wheat (tons)

S W

0 30

1.5 29

3 28

4.5 27

6 26

7.5 25

9 24

10.5 23

12 22

13.5 21

15 20

16.5 19

18 18

19.5 17

S W

20 0

18.5 1

17 2

15.5 3

14 4

12.5 5

11 6

9.5 7

8 8

6.5 9

5 10

3.5 11

US only makes wheat

Brazil only makes sugar

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USA Brazil

1W = 1.5S

Su

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ns)

Su

gar

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ns)

45

40

35

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10

5

0

30

25

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15 10 5

05 10 15 20 25 30 5 10 15 20

AFTER TRADE

AFTER TRADE

Wheat (tons) Wheat (tons)

International Trade

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USA BrazilTrade allows a

country to consume

outside of its PPC!

Su

gar

(to

ns)

Su

gar

(to

ns)

45

40

35

30

25

20

15

30

25

20

15 10

5 10 15 20 25 30 5 10 15 20Wheat (tons) Wheat (tons)

USA

Brazil

Wheat Sugar

30 30

10 20

(1W costs 1S) (1S costs 1W)

(1W costs 2S) (1S costs 1/2W)

Which country has a comparative advantage in wheat?

1. Which country should EXPORT Sugar?2. Which country should EXPORT Wheat?

32

Which country has a comparative advantage in sugar?

Do Now

Suppose there are two young men, Liam and Harry, who enjoy knitting. The number of headbands or scarves each man can knit in one day is shown in the table below. Who has a comparative advantage in knitting headbands? Scarves? Who has an absolute advantage in headbands? Scarves?

Liam

Harry4 810 10

ScarvesHeadbands

1.Pick up Economic Systems notes packet from cart 2.Answer the following in your notebook (use your Trade

and Comparative Advantage Notes if necessary:

Liam

Harry

Headbands Scarves

4 8

10 10

(1H costs 2S) (1S costs 0.5H)

(1H costs 1S) (1S costs 1H)

Who has an absolute advantage in headbands?Who has an absolute advantage in scarves?

Who has a comparative advantage in scarves?

34

Who has a comparative advantage in headbands?

Namibia

Chile

Copper Steel

15 45

40 80

(1C costs 3S) (1S costs 1/3C)

(1C costs 2S) (1S costs 1/2C)

Which country has a comparative advantage in copper?

1. Which country should IMPORT steel?2. Which country should EXPORT copper?

35

Which country has a comparative advantage in steel?

Argentina

France

Wine Beef

64 16

75 50

(1W costs 0.25B) (1B costs 4W)

(1W costs 0.67B) (1B costs 1.5W)

Which country has a comparative advantage in wine?

1. Which country should produce beef?2. Which country should produce wine?

36

Which country has a comparative advantage in beef?

Economic Systems

Every society must answer three questions:

1. What should be produced? 2. How should it be produced? 3. Who gets to consume it?

The way these questions are answered determines the economic system

An economic system is the method used by a society to produce and distribute goods and

services. 38

Economic Systems

1.Command Economy2.Free Market Economy3.Mixed Economy

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Command Economies

40

In a command economy – also called a centrally planned economy – the government… 1. owns all the resources 2. answers all three economic questions

Examples:Cuba, North Korea, former Soviet Union

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Centrally planned economies often face problems of poor quality goods, shortages, and unhappy citizens. Why do you think this is?

Incentive: a thing that motivates or encourages someone to do something

Government policies can influence the way people behave by changing people’s incentives

These incentive changes may be intended or unintended

Incentives

Socialism and Communism“From each according to his ability, to each

according to his needs”

Characteristics:1. Abolition of private

property2. State ownership of

all resources3. Central planning4. Elimination of

social classes

Karl Marx

Advantages and Disadvantagesof Socialism/Communism

1. Equality!2. Health care for all!3. Jobs for all!4. No class warfare

because there are no classes!

Pros Cons1. Not much incentive

to work too hard2. Little incentive to

innovate. No competition keeps quality of goods from improving.

3. Lots of opportunities for corruption

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Incentives in the Soviet UnionSoviet companies were not guided by prices or profit. Gov’t officials set

arbitrary output quotas based on quantitative measurements. Businesses were paid based on meeting these quotas.

1. Because of weight-based production quotas for certain products, businesses would often fill products with lead to make them heavier that were almost too heavy to carry

2. Light bulb producers would only make tiny night light size bulbs because of production quotas based on number of bulbs produced.

3. Oil companies would intentionally drill many shallow holes when they knew that oil deposits are usually found in deep holes that require slower drilling, because companies were required to drill a certain number of feet

45

4. Construction superintendents would order workers to remove bathtubs from first floor and install them in the third floor while he slowly lead inspectors through apartment building, because businesses were paid based on number of apartments complete at time of inspection.

5. State-owned businesses would receive resources – e.g. functioning light bulbs – before the public did. Employees would often steal bulbs from work and replace them with burnt out bulbs. A black market for burnt out bulbs developed.

Incentives in the Soviet Union

Do Now1. Take out your Economic Systems notes2. Answer the following in your notebook:

In the United States, the wealthiest people must give 39.6% of their income (above ~$400,000) to the federal government as income tax. Meanwhile, 43% of low-income Americans pay no federal income tax at all. In your opinion, is this fair? Explain.

2015 Tax Brackets

Review 1. What are the three economic questions

that every society must answer?2. Who decides how the three questions

are answered in a command economy?3. What are the main characteristics of a

socialist/communist economic system?4. What are some problems with

socialism/communism?

Free Market Capitalism

Characteristics of Free Markets

1. Little government involvement in the economy. (Laissez Faire = Let it be)

2. Individuals own resources and answer the three economic questions.

3. The opportunity to make PROFIT gives people the INCENTIVE to produce quality items efficiently.

4. Wide variety of goods available to consumers.

5. Competition and self-interest work together to keep prices down and quality up.

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Adam Smith and the “Invisible Hand” of the Free Market

How the free market regulates itself:Suppose consumers want laptops and are willing to pay for them…• Businesses have an INCENTIVE to start making laptops to earn PROFIT.

• This leads to more COMPETITION….• Which means lower prices, better quality, and more product variety.

• We produce the goods and services that society wants because “resources follow profits.”

End Result: Most efficient production of the goods that consumers want, produced at the lowest prices and the highest quality.

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The Invisible HandThe idea that society’s goals will be met as

individuals seek their own self-interest.

Example: Society wants fuel efficient cars…• Profit-seeking producers will make more.• Competition between firms results in low prices, high quality, and greater efficiency.

• The government doesn’t need to get involved since the needs of society are automatically met. Competition and self-interest act as an

invisible hand that regulates the free market.54

Why socialism/communism fails:If consumers want laptops and only one state-owned company is making them… • Other businesses CANNOT start making laptops.

• There is NO COMPETITION…• Which means higher prices, lower quality, and less product variety.

• More laptops will not be made until the government decides to expand production

The End Result: There is a shortage of goods that consumers want, produced at

higher prices and lower quality.55

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1. Companies are greedy and will do anything to screw over consumers!

• Companies have an incentive to satisfy the needs of consumers. If they don’t they will go out of business.

2. Capitalism causes companies to outsource US jobs overseas. America suffers because companies want more profit!

• The number of people who benefit from lower prices far exceed the number of people who lose jobs

3. Capitalism only helps the rich. US companies enslave and exploit third-world workers in sweatshops!

• Sweatshop workers are not forced labor. They make the decision to work there voluntarily. Why?

• Although the working conditions are far below US standards, working in a sweatshop is usually better than the alternative• Sweatshop wages in Vietnam, Honduras, and

Nicaragua are often dramatically higher than the average wages in those countries

Criticisms of Capitalism

GDP Per Capita Heat Map

Economic Freedom Heat Map

The degree of economic freedom in a country correlates strongly with per capita wealth

North Korea's GDP is $40 BillionSouth Korea's GDP is $1.45 Trillion (36 times greater).

Mixed Economies

Countries in blue have mixed economies

Mixed economies feature some characteristics of both command and market economies

Even the freest countries have some socialist characteristics

The biggest knock on capitalism is that it leads to wealth inequality

Many countries attempt to mitigate this with redistributive policies like progressive income taxes and generous social welfare programs

The Socialist Temptation

Heritage Foundation Index of Economic Freedom Rankings

Homework Review

1. What is the difference between absolute and comparative advantage?

Absolute advantage – doing something better and/or more efficiently

Comparative advantage – doing something at a lower opportunity cost

2. What does the law of comparative advantage say?

If everyone specializes in the activity in which they have the lowest opportunity cost, everyone will be better off

  Berets Lederhosen

Germany 50 25

France 40 5

The table above shows the production alternatives of two countries, France and Germany, which produce berets (a type of hat) and lederhosen (a type of pants) using equal amounts of resources.

  Berets Lederhosen

Germany 50 25

France 40 5

Which country has an absolute advantage in beret production?

Germany

  Berets Lederhosen

Germany 50 25

France 40 5

Which country has an absolute advantage in lederhosen production?

Germany

  Berets Lederhosen

Germany 50 25

France 40 5

What is the opportunity cost to France of producing 1 pair of lederhosen?

8 berets

  Berets Lederhosen

Germany 50 25

France 40 5

What is the opportunity cost to Germany of producing 1 beret?

½ lederhosen

  Berets Lederhosen

Germany 50 25

France 40 5

Which country has a comparative advantage in lederhosen production?

Germany

  Berets Lederhosen

Germany 50 25

France 40 5

Which country has a comparative advantage in beret production?

France

  Berets Lederhosen

Germany 50 25

France 40 5

According to the law of comparative advantage, which country should specialize in berets?

France

  Berets Lederhosen

Germany 50 25

France 40 5

According to the law of comparative advantage, which country should specialize in lederhosen?

Germany

1.List three advantages of socialism/communism.

1.List three disadvantages of socialism/communism.

Advantages and Disadvantagesof Socialism/Communism

1. Equality!2. Health care for all!3. Jobs for all!4. No class warfare

because there are no classes!

Pros Cons1. Not much incentive

to work too hard2. Little incentive to

innovate. No competition keeps quality of goods from improving.

3. Lots of opportunities for corruption

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6. Explain how the “invisible hand” of the free market regulates the production of a good or service that you enjoy. How is it possible that it can be provided without the government forcing someone to produce it?