Welcome to ECON1101!
ECON1101 – Microeconomics 1
Chapter 1: Comparative
Advantage & the Basis for Trade
What is Economics?
Chapter 1: Comparative AdvantageECON1101 - Microeconmics 1
What is a model?
Definition:
A Model is a simplified representation of reality.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
What are characteristics of a good model?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
How do we use economic models?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
What are the ingredients of an economic model?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Your First Model
A One-Agent Economy
Your First Model
Question: Why do we have markets?
Assumptions:
• There are 2 possible activities.
• There are 2 individuals.
• When trading, there are
– no transaction costs (negotiation/transportation costs),
– no other barriers to trade (import quotas, tariffs).
Chapter 1: Comparative AdvantageECON1101 - Microeconmics 1
A One-Agent Economy
Agents:
• Agent 1 lives on a desert island.
• She has two productive activities:
– Fishing and picking coconuts.
• Each activity requires the use of resources:
– 1 hour for each fish.
– 1 hour for each coconut.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A One-Agent Economy
Constraint:
• Resources are scarce.
• Time is limited:
24 hrs./day – 8 hrs./day of sleep = 16 hrs. available
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A One-Agent Economy
What possible combinations of fish and coconuts can she produce?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A One-Agent Economy
The production possibility curve (PPC):
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A One-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
The production possibility curve captures the maximum output
possibilities for two (or more) goods, given a set of inputs, if
inputs are used efficiently.
A One-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An efficient production point represents a combination of goods
for which currently available resources do not allow an increase
in the production of one good without a reduction in the
production of the other.
All the points on the PPC are efficient.
A One-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An inefficient production point represents a combination of
goods for which currently available resources allow an increase
in the production of one good without a reduction in the
production of the other.
All the points inside of the PPC are inefficient.
A One-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An attainable production point represents any combination of
goods that can be produced with the currently available
resources.
All the points on or inside of the PPC are attainable.
A One-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An unattainable production point represents any combination of
goods that cannot be produced with the currently available
resources.
All the points outside of the PPC are unattainable.
A One-Agent Economy
• We now know how much she can produce, but have not said
anything how much she wants to produce.
Objective:
• She wants to consume as much of both items as possible.
• She prefers to consume fish and coconuts in equal quantities.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A One-Agent Economy
How much will she produce and consume?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Fish/day
Coconuts/day
0 16
16
Expanding the Model
A Two-Agent Economy
A Two-Agent Economy
Agent 2:
• Constraint: 16 hours to spend fishing or picking coconuts.
• Resources:
– 2 hours for each fish.
– 4 hours for each coconut.
• Objective:
– Wants to eat as much coconut as possible.
– Does not like seafood.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A Two-Agent Economy
Agent 2’s PPC:
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Fish/day
Coconuts/day
0 16
16
A Two-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An agent has an absolute advantage in a productive activity
when he/she can carry out the activity with fewer resources
than another agent.
A Two-Agent Economy
Time to Produce Each Good
• ________ has an absolute advantage in ________.
• ________ has an absolute advantage in ________.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Coconuts Fish
1 hour 1 hour
4 hours 2 hours
A Two-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
The opportunity cost of a given action is the value of the next
best alternative to that particular action.
A Two-Agent Economy
Calculating opportunity cost:
OCCoconuts = (loss in fish/gain in coconuts)
OCFish = (loss in coconuts/gain in fish)
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A Two-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
An agent has a comparative advantage in a productive activity
when he/she has a lower opportunity cost of carrying out the
activity than another agent.
A Two-Agent Economy
Time to Produce Each Good
• ________ has a comparative advantage in ________.
• ________ has a comparative advantage in ________.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Coconuts Fish
1 hour 1 hour
4 hours 2 hours
Opp. Cost of Fish
A Two-Agent Economy
Opportunity cost on a PPC:
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Fish/day
Coconuts/day
0 16
16
4
8
A Two-Agent Economy
Can our two agents produce more when they specialise?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
No Specialisation Specialisation
Coconuts Fish Coconuts Fish
8 8
4 0
A Two-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Principle of Comparative Advantage:
Everyone is better off if each agent specialises in the activities for
which they have a comparative advantage.
The gains from specialisation are larger the greater is the
difference in opportunity costs!
Comparative Advantage Applied to Music
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
“Maybe Ringo Starr wasn’t the best drummer in the world.
Alright, maybe he wasn’t the best drummer in the Beatles…”
– from Radio 4 sketch comedy Radio Active,
broadcast 6 Oct. 1981.
(Not actually said by John Lennon)
A Two-Agent Economy
Question: Why do we have markets?
• Can both of our agents do better than producing for
themselves?
• Yes!!! If they specialise according to comparative advantage
and trade.
…but at what price?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
A Two-Agent Economy
Time to Produce Each Good
• __________ will trade if ℎ > ____________
• __________ will trade if ℎ < ____________
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Coconuts Fish
1 hour 1 hour
4 hours 2 hours
Opp. Cost of Fish
1 Coconut
½ Coconut
A Two-Agent Economy
Without Trade
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Produce Consume
Coconuts Fish Coconuts Fish
8 8 8 8
4 0 4 0
A Two-Agent Economy
With Trade
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Produce Consume
Coconuts Fish Coconuts Fish
A Two-Agent Economy
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Principle of Increasing Opportunity Cost
(Low Hanging Fruit):
In the process of increasing the production of any good, first
employ those resources with the lowest opportunity cost and
only once these are exhausted turn to resources with higher cost.
The Economy-Wide PPC
and Trade Between Economies
The Economy-Wide PPC (2 agent economy)
What combinations of goods can both agents produce together?
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Fish/day
Coconuts/day
0
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
The Economy-Wide PPC (many-agent economy)
Fish/day
Coconuts/day
0
The Economy-Wide PPC
What could cause the economy-wide PPC to shift?
• Changes in capital or infrastructure:
– roads, factories, equipment.
• Changes in population:
– labor force.
• Changes is knowledge and technology:
– education, R&D, information/communications tech.
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Trading Between Economies
• The principle of comparative advantage applies to countries as
well as to individuals.
• A country’s economic welfare depends on what it consumes,
not what it produces.
• Consumption possibility curve (CPC).
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Trading Between Economies
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage
Definition:
The consumption possibility curve represents all possible
combinations of two goods that the economy can feasibly
consume.
Trading Between Economies
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage Fish/day
Coconuts/day
0
Classic Critiques to the Model
We assumed:
• no psychological cost of performing the same activity all day
– Boredom doesn’t kill you!
• no transaction costs connected with trading
– i.e., negotiation costs, transportation costs, etc
• no import quotas or tariffs
– similar to transaction costs
• no change in preferences after trading and no accounting for social
norms that might prevent trading
ECON1101 - Microeconmics 1 Chapter 1: Comparative Advantage

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