6-Oct-23

1
UNIT

MICROECONOMICS

Prepared by: HPL

© 2023 Foreign Trade University AP Microeconomics Hoang Phu LY

A short introduction …about me...

LÝ Hoàng Phú – PhD

Head of the Department of
Development Economics
Faculty of International
Economics
Foreign Trade University
[email protected]
Mobile: 0944904968

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My teaching rules

• Friendly

• =>

• Fair evaluation

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and You…?
1. Academic performance

2. Explore interests

3. Career Exploration

4. Personal Development

5. College and Post-Secondary Planning

6. Standardized Tests

7. Financial Literacy

8. Networking and Relationships

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© 2002
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Ray Fair
Phu LY 5

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Student Evaluation

• Tests 75%

Students take two 50-question, multiple-choice

tests for the first three 6-week quarters in an 24-
week semester. In the fourth 6 weeks, students
take one 50-question, multiple- choice test and
one free-response test that has one long question
and two short questions. Tests use AP-style free
response and multiple-choice questions.

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Online Assignments and Quizzes 20%

• Students take four short online quizzes that

include AP-style questions every 6 weeks.

The remaining 5 percent of a student’s grade

comes from daily grades. These consist primarily
of completing test corrections and daily quizzes.

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Resources

• Nicholas Gregory Mankiw, Principles of

Microeconomics, 9th ed., Publisher, Cengage
Learning; ISBN-13, 978-0357133484

• Margaret Ray, David Anderson. Krugman’s

Economics for AP 2e. Worth Publishers, 2015;
ISBN-13: 978-1-4641-2218-7.

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10

1
UNIT

UNIT 1: : BASIC
ECONOMIC CONCEPTS

Prepared by: HPL

© 2023 Foreign Trade University AP Microeconomics Hoang Phu LY

Unit’s outline

• Module 1: The study of economics

• Chapter 1: Ten principles of economics
• Chapter 2: Thinking like an economist

• Module 2: The production possibility curve

• Chapter 3: Interdependence and gain from trade

• Module 3: Comparative advantage and trade

• Chapter 3: (continued)

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What will you study?

• The foundations of microeconomic thinking,

including:
• how to evaluate decisions based on constraints
• trade-offs
• make rational economic choices.

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Topics may include:

1. Scarcity

2. Resource allocation and economic systems

3. Cost-benefit analysis

4. Marginal analysis and consumer choice

5. The Production Possibilities Curve

6. Comparative advantage and gains from trade

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MODULE 1

BASIC ECONOMIC CONCEPTS

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MODULE 1
CHAPTER 1
TEN PRINCIPLES OF ECONOMICS

MICROECONOMICS for AP
Mankiw, Principles of Microeconomics
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LEARNING OBJECTIVES:
By the end of this chapter, students should
understand:
1. that economics is about the allocation of scarce
resources.
2. that individuals face trade-offs.
3. the meaning of opportunity cost.
4. how to use marginal reasoning when making decisions.
5. how incentives affect people’s behavior.
6. why trade among people or nations can be good for
everyone.
7. why markets are a good, but not perfect, way to
allocate resources.
8. what determines some trends in the overall economy.

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What you will learn in this

chapter:
1. Economics and Economic system
2. How scarcity and individual choice are central to the
study of economics?
3. The importance of opportunity cost in individual choice
and decision making
4. What makes macroeconomics different from
microeconomics
5. When economists agree and why sometimes disagree
6. The difference between positive economics and
normative economics

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1.1. INTRODUCTION TO ECONOMICS

1.1.1. ECONOMICS AND ECONOMIC SYSTEM

1.1.2. FACTORS OF PRODUCTION

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1.1.1. ECONOMICS AND ECONOMIC SYSTEM

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Economics

• Economics is the science of scarcity.

• Scarcity is the condition in which our wants are greater
than our limited resources.
• Since we are unable to have everything we desire, we
must make choices on how we will use our resources.
• In economics we will study the choices of individuals,
firms, and governments.
choices
Economics is the study of _________.

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Examples:
You must choose between buying jeans or buying shoes.
Businesses must choose how many people to hire
Governments must choose how much to spend on welfare.

Economics Defined
Economics-Social science concerned with the efficient use of
limited resources to achieve maximum satisfaction of economic
wants.
scarcity
(Study of how individuals and societies deal with ________)

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What is an economy?

• An economy is a system for coordinating

society’s productive activities.
• => Economic system (next slide)

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Every society must answer three economic

questions:
1. What goods and services should be
produced?
2. How should these goods and services be
produced?
3. Who consumes these goods and services?`
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.

23
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Economic Systems

1. Centrally Planned
(Command) Economy
2. Free-Market Economy
3. Mixed Economy

24
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Command Economy/Central Planned

economy

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Market economy

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Mixed economy

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1.1.2. FACTORS OF PRODUCTION

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Resources = Factor of production

• A resource is anything that can be used to produce

something else.

• Natural resources

• Capital resources

• Human resources

• Technology is sometimes referred to as

entrepreneurship

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The Factors of Production

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Resources (Factor of production) Are

Scarce
• Natural resources (Land): including timber, water, minerals,
and all other resources that come from nature

• Capital resources: machinery, buildings, tools, and all other

manufactured goods used to make other goods and services

• Labor resource: workers quantity and effort & ability

• Entrepreneurship or technology (the implementation of the

latest knowledge, skills, methods, and processes in doing
things, the educational achievements and skills of workers).

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1.2. TEN PRINCIPLES OF

ECONOMICS
• 1.2.1. HOW PEOPLE MAKE DECISIONS

• 1.2.2. HOW PEOPLE INTERACT

• 1.2.3. HOW ECONOMY AS A WHOLE WORKS

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1.2.1. HOW PEOPLE MAKE DECISIONS

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1.2.1. HOW PEOPLE MAKE DECISIONS

• 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 Responds To Incentives

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Principle #1: People Face Trade – offs

• Choices Are Necessary Because

Resources Are Scarce

there are not enough of the resources

are available to satisfy all the various
ways a society wants to use them.

Scarcity and Individual Choice: The

Core of Economics
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Scarcity Means There Is Not Enough For

Everyone

Government must step in to help allocate

(distribute) resources
36
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Individual choice

• Every economic issue involves, at its most basic

level, individual choice about what to do and
what not to do.
 Individual choice is the decision by an individual of
what to do, which necessarily involves a decision of
what not to do.
 In fact, you might say that it isn’t economics if it isn’t
about choice.

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• Principle #1: People Face Trade – offs = People

must make choices because resources are
scarce.

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Principle 2: The Cost of Something Is

What You Give Up to Get It
• The opportunity cost of an item—what you must
give up in order to get it —is its true cost.

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Opportunity Cost

• Opportunity cost is the best alternative that we

forgo, or give up, when we make a choice or a
decision = what you must give up in order to get it.

• Opportunity costs arise because time and

resources are scarce. Nearly all decisions involve
trade-offs.

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Trade-offs
ALL decisions involve trade-offs.

Trade-offs are all the alternatives that we give up

whenever we choose one course of action over others.
(Examples: going to the movies)
The most desirable alternative given up as a result of a
decision is known as opportunity cost.

What are trade-offs of deciding to go to college?

What is the opportunity cost of going to college?

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Free things are not truly free

• Free Shipping: Some online retailers offer free shipping

on orders, but they may raise the prices of the products
to compensate for the shipping cost.

• Free Mobile Apps: Many mobile apps are available for

free download, but they often generate revenue through
advertisements or by collecting user data, which can be
sold to third parties. These apps may track your
location, browsing habits, or personal information,
compromising your privacy

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Principle #3: Rationale People Think at

the Margin
• “How much” decisions require making trade-offs
at the margin: comparing the costs and benefits
of doing a little bit more of an activity versus
doing a little bit less.

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Thinking at the Margin

# Times Benefit Cost

Watching Movie

1st $30 $10

2nd $15 $10
3rd $5 $10
Total $50 $30
Would you see the movie three times?
Notice that the total benefit is more than the
total cost but you would NOT watch the movie
the 3rd time.
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Marginal Analysis
In economics the term marginal = additional

“Thinking on the margin,” or MARGINAL

ANALYSIS involves making decisions based on
the additional benefit vs. the additional cost.
For Example:
You have been shopping at the mall for a half hour; the
additional benefit of shopping for an additional half-
hour might outweigh the additional cost (the opportunity
cost).
After three hours, the additional benefit from staying an
additional half-hour would likely be less than the
additional cost.
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Marginalism

• In weighing the costs and benefits of a decision,

it is important to weigh only the costs and
benefits that arise from the decision.
• Suppose that flying a 200-seat plane across the
country costs the airline $100,000, which means that
the average cost of each seat is$500. Suppose that
the plane is minutes from departure and a passenger
is willing to pay $300 for a seat. Should the airline
sell the seat for $300? In this case, the marginal cost
of an additional passenger is very small.

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Marginal cost is not sunk cost

• When deciding whether to produce additional

output, a firm considers only the additional (or
marginal cost), not the sunk cost.

• Sunk costs are costs that have already been

incurred and cannot be recovered. If you buy a
non-refundable ticket for a concert, sporting
event, or travel but later decide not to attend,
the cost of the ticket is a sunk cost. Regardless
of whether you use the ticket or not, the money
spent on it is irrecoverable

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Principle #4: People respond to

incentives
• People usually respond to incentives,
exploiting opportunities to make themselves
better off.

• Incentive: something that induces a person to act

• a. When the price of a good rises, consumers will buy
less of it because its cost has risen.
• b. When the price of a good rises, producers will
allocate more resources to the production of the good
because the benefit from producing the good has
risen.

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Principle #4: People respond to

incentives

Marginal changes in costs or benefits

motivate people to respond.

The decision to choose one alternative over

another occurs when that alternative’s
marginal benefits exceed its marginal costs!

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Some more examples…

 Give some example

about your incentive
–base acts?

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1.2.2. HOW PEOPLE INTERACT

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1.2.2. HOW PEOPLE INTERACT

• 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

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Principle #5: Trade can make everyone

better off

 People gain from their ability to trade with one

another.

 Competition results in gains from trading.

 Trade allows people to specialize in what

they do best.

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Activity 1—Getting Dressed in the

Global Economy
• Time: 25 minutes

• Class limitations: group of 5 peoples

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Activity 1—Getting Dressed in the

Global Economy
Answer the following questions:

1. Where did your clothes come from?

2. Who worked to produce your clothes?

3. What things do you consider when buying a

garment?

4. Where were your clothes produced (what

countries)?

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Principle #6: Markets are usually a good

way to organize economic activity

In a market economy, households

decide what to buy and who to
work for.

Firms decide who to hire and what

to produce.

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#6. Markets are usually a good way

to organize economic activity

Adam Smith made the

observation that households
and firms interacting in
markets act as if guided by an
“invisible hand.”

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#6. Markets are usually a good way

to organize economic activity

Because households and firms look at prices

when deciding what to buy and sell, they
unknowingly take into account the social costs
of their actions.

As a result, prices guide decision makers to

reach outcomes that tend to maximize the
welfare of society as a whole.

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Principle #7: Governments can

sometimes improve market outcomes

• When the market fails (breaks down)

government can intervene to
promote efficiency and equity.

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#7. Governments can sometimes improve

market outcomes.

Market failure occurs when

the market fails to allocate
resources efficiently.

60

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#7. Governments can sometimes improve

market outcomes.

Market failure may be caused by

an externality, which is the impact
of one person or firm’s actions on
the well-being of a bystander.

61

# 7. Governments can sometimes

improve market outcomes.

Market failure may also be caused

by market power, which is the ability
of a single person or firm to unduly
influence market prices.

62

1.2.3. HOW THE ECONOMY AS A WHOLE

WORKS

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Principle #8: The standard of living

depends on a country’s production

Standard of living may be measured

in different ways:
By comparing personal incomes.

By comparing the total market value of a

nation’s production.

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#8. The standard of living depends on a

country’s production

Almost all variations in living

standards are explained by
differences in countries’
productivities.

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#8. The standard of living depends on a

country’s production.

Productivity is the amount of goods

and services produced from each
hour of a worker’s time.

Higher productivity  Higher standard of living

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Principle #9: Prices rise when the

government prints too much money.

Inflation is an increase in the overall

level of prices in the economy.
One cause of inflation is the growth in the
quantity of money.

When the government creates large

quantities of money, the value of the money
falls.

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Principle #10: Society faces a short-run tradeoff

between inflation and unemployment

• Most economists believe that the short-run effect

of a monetary injection is lower unemployment
and higher prices.
• a. An increase in the amount of money in the economy
stimulates spending and increases the quantity of
goods and services sold in the economy. The increase
in the quantity of goods and services sold will cause
firms to hire additional workers.
• b. An increase in the demand for goods and services
leads to higher prices over time.

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Principle #10: Society faces a short-run tradeoff

between inflation and unemployment

The Phillips Curve illustrates the tradeoff

between inflation and unemployment:

Inflation  Unemployment
It’s a short-run tradeoff!

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Phillips Curve

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5 Key Economic Assumptions

1. Society’s wants are unlimited, but ALL resources are
limited (scarcity).
2. Due to scarcity, choices must be made. Every choice has a
cost (a trade-off).
3. Everyone’s goal is to make choices that maximize their
satisfaction. Everyone acts in their own “self-interest.”
4. Everyone acts rationally by comparing the marginal costs
and marginal benefits of every choice
5. Real-life situations can be explained and analyzed
through simplified models and graphs.

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Activity 2—So Many Things to Do, So

Little Time
• Time: 10 minutes

• Class limitations: by individual answer

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• You have 24 hours per day. How do you organize your

daily activities? Do a list of activities with corresponding
time requirements (example: sleep, breakfast, go to
class, ….

• Which Principle of Economics this illustrates?

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Given the following assumptions, make a rational choice

in your own self-interest (hold everything else constant)…

1. You want to visit your friend for the weekend

2. You work every weekday earning $100 per day
3. You have three flights to choose from:
Thursday Night Flight = $300
Friday Early Morning Flight = $345
Friday Night Flight = $380

Which flight should you choose? Why?

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How to Read This Book

• Read before class.
• Summarize, don’t highlight.
• Test yourself.
• Practice, practice, practice.
• Go online.
• Study in groups.
• Teach someone.
• Don’t skip the real-world examples.
• Apply economic thinking to your daily life.

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Questions for Review

1. Give three examples of important tradeoffs that you

face in your life.

2. What is the opportunity cost of seeing a movie?

3. Water is necessary for life. Is the marginal benefit of

a glass of water large or small?

4. Why should policymakers think about incentives?

5. Why isn’t trade among countries like a game with

some winners and some losers?

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• 6. What does the “invisible hand” of the

marketplace do?

• 7. Explain the two main causes of market

failure and give an example of each.

• 8. Why is productivity important?

• 9. What is inflation, and what causes it?

• 10. How are inflation and unemployment related

in the short run?

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Problems and Applications

• Students should prepare at home before the

correction at class (during about one class hour)

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MODULE 1
CHAPTER 2
THINKING LIKE AN ECONOMIST

MICROECONOMICS for AP
Mankiw, Principles of Microeconomics
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LEARNING OBJECTIVES

• how economists apply the methods of science.

• how assumptions and models can shed light on the world.
• two simple models—the circular flow and the production
possibilities frontier.
• the difference between microeconomics and
macroeconomics.
• the difference between positive and normative
statements.
• the role of economists in making policy.
• why economists sometimes disagree with one another.

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I. The Economist as Scientist

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Every field of study has its own

terminology

Mathematics
integrals
axioms Psychology
vector spaces
ego
id
cognitive
Law dissonance
torts Promissory
estoppel
venues

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Every field of study has its own

terminology

Economics

Supply Opportunity Elasticity

cost

Consumer
Comparative
Surplus
advantage
Deadweight loss
Demand
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Economics trains you to. . . .

Think in terms of alternatives.

Evaluate the cost of individual and social

choices.

Examine and understand how certain

events and issues are related.

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The Economist as a Scientist

The economic way of thinking . . .

Involves thinking analytically and objectively.

Makes use of the scientific method.

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The Scientific Method

Uses abstract models to help explain

how a complex, real world operates.

Develops theories, collects, and

analyzes data to prove the theories.

Observation, Theory and More Observation!

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The Role of Assumptions

 Economists make assumptions in order

to make the world easier to understand.

 The art in scientific thinking is deciding

which assumptions to make.

 Economists use different assumptions to

answer different questions.

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The Economic Way of Thinking

Includes developing abstract models

from theories and the analysis of the
models.

Uses two approaches:

 Descriptive (reporting facts, etc.)
 Analytical (abstract reasoning)

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Economic Models

 Economists use models to simplify reality in

order to improve our understanding of the world

Most economic models are composed of

diagrams and equations.

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MODULE 2
THE PRODUCTION POSSIBILITIES
CURVE MODEL

MICROECONOMICS for AP
Mankiw, Principles of Microeconomics
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CHAPTER 2: THINKING LIKE

AN ECONOMIST
Continued

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Two of the most basic economic

models include:
• 1. The Circular Flow Model

• 2. The Production Possibilities Frontier

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Example of Model

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Example of Model

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The Circular-Flow Model

• The circular-flow model is a

simple way to visually show the
economic transactions that occur
between households and firms in
the economy.

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The Circular-Flow Diagram

Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms
Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and profit
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The Circular-Flow Diagram

Firms
 Produce and sell goods and services
 Hire and use factors of production
Households
 Buy and consume goods and services
 Own and sell factors of production
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The Circular-Flow Diagram

Markets for Goods & Services
 Firms sell
 Households buy
Markets for Factors of Production
 Households sell
 Firms buy
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The Circular-Flow Diagram

Factors of Production

 Inputs used to produce goods and

services

 Land, labor, and capital

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The Production Possibilities Frontier

• The production possibilities frontier is a

graph showing the various combinations
of output that the economy can possibly
produce given the available factors of
production and technology.

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The Production Possibilities

Frontier

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The Production Possibilities

Frontier

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The Production Possibilities

Frontier

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The Production Possibilities

Frontier

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A Shift in the Production Possibilities Frontier

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Concepts Illustrated by the Production

Possibilities Frontier

Efficiency

Tradeoffs

Opportunity Cost

Economic Growth

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Microeconomics and Macroeconomics

 Microeconomics focuses on the individual

parts of the economy.
 How households and firms make decisions and
how they interact in specific markets
 Macroeconomics looks at the economy as a
whole.
 How the markets, as a whole, interact at the
national level.

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II. The Economist as Policy Adviser

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Two Roles of Economists

 When they are trying to explain the

world, they are scientists.
 When they are trying to change the
world, they are policymakers or policy
advisors.

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Positive versus Normative Analysis

Positive statements are statements that

describe the world as it is.
 Called descriptive analysis
Normative statements are statements
about how the world should be.
 Called prescriptive analysis

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Positive or Normative Statements?

An increase in the minimum wage

will cause a decrease in
?
employment among the least-
skilled.

?
112

Positive or Normative Statements?

A lower minimum wage would allow

businesses to thrive and create
more job opportunities
?

? ? 113

Positive or Normative Statements?

? The income gains from a higher?

minimum wage are worth more than
any slight reductions in employment.

? ? 114

38
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Positive or Normative Statements?

? Governments should collect from

?
tobacco companies the costs of
treating smoking-related illnesses
among the poor.

? 115

Economists in Washington . . .

. . . serve as advisers in the

policymaking process of the three
branches of government:
 Legislative
 Executive
 Judicial

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III. Why Economists Disagree?

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Why Economists Disagree

They may disagree on theories about

how the world works.

They may hold different values and,

thus, different normative views.

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Examples of What Most Economists

Agree On

A ceiling on rents reduces the quantity

and quality of housing available.

Tariffs and import quotas usually reduce

general economic welfare.

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IV. Why You Should Study Economics?

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IV. Why You Should Study Economics?

• Understanding how the economy works

• Making informed personal financial decisions

• Analyzing public policy issues

• Enhancing critical thinking and problem-solving

skills

• Career opportunities

• Understanding global issues

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Summary

In order to address subjects with

objectivity, economics makes use of
the scientific method.

The field of economics is divided into

two subfields: microeconomics and
macroeconomics.

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Summary
Economics relies on both positive and
normative analysis. Positive statements
assert how the world “is” while normative
statements assert how the world “should be.”

Economists may offer conflicting advice due

to differences in scientific judgments or to
differences in values.

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Graphical
Review

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The Circular-Flow Diagram

Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms
Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
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The Production Possibilities

Frontier
Quantity of
Computers
Produced
3,000 D

2,200
C
2,000 A

B
1,000

0 300 600 700 1,000 Quantity of

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 6-Oct-23

The Production Possibilities

Frontier
Quantity of
Computers
Produced
3,000 D

2,200
C
2,000 A
Production
possibilities
frontier
B
1,000

0 300 600 700 1,000 Quantity of

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Phu LY 127

Quantity The Production

of Computers
Produced Possibilities Frontier
4,000
An outward shift
in the production
3,000 possibilities
frontier

E
2,100
2,000
A

0 700 750 1,000 Quantity of

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Fair LY 128

How to Read and Understand Graphs

• Each point on the Cartesian

plane is a combination of
(X,Y) values.

• The relationship between X

and Y is causal. For a given
value of X, there is a
corresponding value of Y, or
X causes Y.

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Reading Between the Lines

• A line is a continuous string

of points, or sets of (X,Y)
values on the Cartesian
plane.
• The relationship between X
and Y on this graph is
negative. An increase in the
value of X leads to a
decrease in the value of Y,
and vice versa.

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Positive and Negative Relationships

An upward-sloping line
describes a positive
relationship between X
and Y.

A downward-sloping
line describes a
negative relationship
between X and Y.

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The Components of a Line

• The algebraic expression of

this line is as follows:
Y = a + bX
where:
Y = dependent variable
X = independent variable
a = Y-intercept, or value of
Y when X = 0.
+ = positive relationship
Y Y Y between X and Y
b=  1 0 b = slope of the line, or the
 X X1  X 0
rate of change in Y
given a change in X.
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Different Slope Values

5 7
b  0.5 b    0.7
10 10

0 10
b 0 b 
10 0

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Strength of the Relationship Between

X and Y

• This line is relatively flat.

Changes in the value of X have
only a small influence on the
value of Y.

• This line is relatively steep.

Changes in the value of X have a
greater influence on the value of
Y.

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The Difference Between a Line and a Curve

Equal increments in Equal increments in

X lead to constant X lead to diminished
increases in Y. increases in Y.

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Interpreting the Slope of a Curve

• Graph A has • Graph B has

a positive and a negative
decreasing slope, then a
slope. positive slope.

• Graph C shows • Graph D

a negative and shows a
increasing negative and
relationship decreasing
between X and slope.
Y.

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CHECK YOUR UNDERSTANDING

1. Explain how each of the following situations

illustrates one of the five principles of interaction.

a. Using the college website, any student who wants

to sell a used textbook for at least $30 is able to sell it to
someone who is willing to pay $30.

b. At a college tutoring co-op, students can arrange to

provide tutoring in subjects they are good in (like
economics) in return for receiving tutoring in subjects they
are poor in (like philosophy).

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MODULE 3
COMPARATIVE ADVANTAGE AND
TRADE

MICROECONOMICS for AP
Mankiw, Principles of Microeconomics
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INTERDEPENDENCE AND
THE GAINS FROM TRADE

Chapter 3

140

In this chapter,
look for the answers to these questions:

• Why do people – and nations – choose to be

economically interdependent?

• How can trade make everyone better off?

• What is absolute advantage?

What is comparative advantage?
How are these concepts similar?
How are they different?

141
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Interdependence

• One of the Ten Principles from Chapter 1:

Trade can make everyone better off.

• We now learn why people – and nations –

choose to be interdependent,
and how they can gain from trade.

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Our Example

• Two countries: the U.S. and Japan

• Two goods: computers and wheat
• One resource: labor, measured in hours
• We will look at how much of both goods
each country produces and consumes
• if the country chooses to be self-sufficient
• if it trades with the other country

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Production Possibilities in the U.S.

• The U.S. has 50,000 hours of labor

available for production, per month.

• Producing one computer requires 100 hours of

labor.

• Producing one ton of wheat requires 10 hours of

labor.

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1
4
5 The U.S. PPF
wheat
(tons) The U.S. has enough labor to
produce 500 computers, or
5,000 5000 tons of wheat,
4,000 or any combination along the
PPF.
3,000

2,000

1,000

Computers
0
100 200 300 400 500
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Ray Fair
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The U.S. Without Trade

wheat
(tons)
Suppose the U.S. uses half its labor
5,000
to produce each of the two goods.
4,000 Then it will produce and consume
250 computers and
3,000 2500 tons of wheat.

2,000

1,000

Computers
0
100 200 300 400 500

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ACTIVE LEARNING 1
Derive Japan’s PPF
Use the following information to draw Japan’s PPF.
• Japan has 30,000 hours of labor available for
production, per month.
• Producing one computer requires 125 hours of
labor.
• Producing one ton of wheat requires 25 hours of
labor.
Your graph should measure computers on the
horizontal axis.
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Japan’s PPF

wheat
(tons)
Japan has enough labor to
produce 240 computers,
2,000 or 1200 tons of wheat,
or any combination
along the PPF.
1,000

0 Computers
100 200 300
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Japan Without Trade

wheat
(tons) Suppose Japan uses half its labor to
produce each good.
2,000 Then it will produce and consume
120 computers and
600 tons of wheat.
1,000

0 Computers
100 200 300
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Consumption With and Without Trade

• Without trade,
• U.S. consumers get 250 computers
and 2500 tons wheat.
• Japanese consumers get 120 computers
and 600 tons wheat.
• We will compare consumption without trade to
consumption with trade.

• First, we need to see how much of each good is

produced and traded by the two countries.

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ACTIVE LEARNING 2
Production under trade
1. Suppose the U.S. produces 3400 tons of wheat.
How many computers would the U.S. be able to
produce with its remaining labor? Draw the
point representing this combination of
computers and wheat on the U.S. PPF.

2. Suppose Japan produces 240 computers.

How many tons of wheat would Japan be able
to produce with its remaining labor? Draw this
point on Japan’s PPF.

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U.S. Production With Trade

wheat
(tons)
5,000 Producing 3400 tons of wheat
requires 34,000 labor hours.
4,000
The remaining 16,000
3,000 labor hours are used to
produce 160 computers.
2,000

1,000

Computers
0
100 200 300 400 500

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Japan’s Production With Trade

wheat Producing 240 computers

(tons) requires all of Japan’s 30,000
labor hours.
2,000
So, Japan would produce
0 tons of wheat.

1,000

0 Computers
100 200 300
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Basic international trade terms

• Exports:
goods produced domestically and sold abroad

To export means to sell domestically produced

goods abroad.

• Imports:
goods produced abroad and sold domestically

To import means to purchase goods produced

in other countries.

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ACTIVE LEARNING 3
Consumption under trade
Suppose the U.S. exports 700 tons of wheat to
Japan, and imports 110 computers from Japan.
(So, Japan imports 700 tons wheat and exports
110 computers.)
 How much of each good is consumed in the
U.S.? Plot this combination on the U.S. PPF.
 How much of each good is consumed in Japan?
Plot this combination on Japan’s PPF.

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U.S. Consumption With Trade

wheat
(tons) computers wheat
5,000 produced 160 3400
+ imported 110 0
4,000 – exported 0 700
= amount
3,000 270 2700
consumed
2,000

1,000

Computers
0
100 200 300 400 500
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Japan’s Consumption With Trade

computers wheat
wheat produced 240 0
(tons)
+ imported 0 700
2,000 – exported 110 0
= amount
130 700
consumed

1,000

0 Computers
100 200 300
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Trade Makes Both Countries Better Off

U.S.
consumption consumption gains from
without trade with trade trade
computers 250 270 20
wheat 2,500 2,700 200
Japan
consumption consumption gains from
without trade with trade trade
computers 120 130 10
wheat 600 700 100
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Where Do These Gains Come From?

• Absolute advantage: the ability to produce a

good using fewer inputs than another producer

• The U.S. has an absolute advantage in wheat:

producing a ton of wheat uses 10 labor hours
in the U.S. vs. 25 in Japan.

• If each country has an absolute advantage

in one good and specializes in that good,
then both countries can gain from trade.

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Where Do These Gains Come From?

• Which country has an absolute advantage in

computers?

• Producing one computer requires

125 labor hours in Japan,
but only 100 in the U.S.

• The U.S. has an absolute advantage in both

goods!
So why does Japan specialize in computers?
Why do both countries gain from trade?

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Two Measures of the Cost of a Good

• Two countries can gain from trade when each

specializes in the good it produces at lowest cost.
• Absolute advantage measures the cost of a good
in terms of the inputs required to produce it.
• Recall:
Another measure of cost is 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.

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Opportunity Cost and

Comparative Advantage
• Comparative advantage: the ability to produce
a good at a lower opportunity cost than another
producer

• Which country has the comparative advantage in

computers?

• To answer this, must determine the opp. cost of

a computer in each country.

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Opportunity Cost and

Comparative Advantage
• The opp. cost of a computer is

• 10 tons of wheat in the U.S., because producing one

computer requires 100 labor hours,
which instead could produce 10 tons of wheat.
• 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!

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Comparative Advantage and Trade

• Gains from trade arise from comparative

advantage (differences in opportunity costs).

• When each country specializes in the good(s)

in which it has a comparative advantage,
total production in all countries is higher,
the world’s “economic pie” is bigger,
and all countries can gain from trade.

• The same applies to individual producers

(like the farmer and the rancher) specializing
in different goods and trading with each other.
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ACTIVE LEARNING 4
Absolute & comparative advantage
Argentina and Brazil each have 10,000 hours of
labor per month.
In Argentina,
• producing one pound coffee requires 2 hours
• producing one bottle wine requires 4 hours
In Brazil,
• producing one pound coffee requires 1 hour
• producing one bottle wine requires 5 hours
Which country has an absolute advantage in the
production of coffee? Which country has a
comparative advantage in the production of wine?
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ACTIVE LEARNING 4
Answers
Brazil has an absolute advantage in coffee:
• Producing a pound of coffee requires only one
labor-hour in Brazil, but two in Argentina.

Argentina has a comparative advantage in wine:

• Argentina’s opp. cost of wine is two pounds of coffee,
because the four labor-hours required
to produce a bottle of wine could instead produce two
pounds of coffee.
• Brazil’s opp. cost of wine is five pounds of coffee.

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Unanswered Questions….

• We made a lot of assumptions about the quantities

of each good that each country produces, trades,
and consumes, and the price at which the
countries trade wheat for computers.
• In the real world, these quantities and prices would
be determined by the preferences of consumers
and the technology and resources in both
countries.
• We will begin to study this in the next chapter.
• For now, though, our goal was merely to
see how trade can make everyone better off.
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CHAPTER SUMMARY

• Interdependence and trade allow everyone to enjoy

a greater quantity and variety of goods & services.

• Comparative advantage means being able to

produce a good at a lower opportunity cost.
Absolute advantage means being able to produce a
good with fewer inputs.

• When people – or countries – specialize in the

goods in which they have a comparative advantage,
the economic “pie” grows and trade can make
everyone better off.
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