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1 Macro Chapter 2 Some Tools of the Economist 6 Learning Goals 1) Define and recognize examples of opportunity costs (repeat of Chapter 1) 2) Discern why voluntary trade creates value 3) Realize why property rights are key to economic progress 4) Illustrate the concepts of tradeoffs, opportunity costs, and growth 5) Recognize that specialization and division of labor lead to higher output levels and living standards 6) List society s three questions and specify the kinds of economic organizations Trade Creates Value A fellow economist mentioned his eighteen- and fifteen-year-old daughters unusual behavior. The older one, a freshman in college, brings her laundry home and expects the younger daughter to launder it. The younger daughter complies- but each time she keeps a piece of clothing that she likes most. Their father told this to the older sister, who laughed and said that s OK; when she comes home and her little sister is away she takes some of the little sister s s clothing. Both sisters know all this, and both seem to view it as a way of trading. Like most trading that is voluntary, both sisters are better off. There are gains from trade in stealing each other s clothes! Q: What will happen to the gains from this kind of trade as the sisters preferences for the clothing they purchase become more similar? Two opposing views of trade: 1. When people trade, one person gains and the other person loses Referred to as a zero-sum game 2. When people trade, both parties gain Wealth is actually created by trade Watch video: Stossel Micro Clip 03- exchange and wealth creation 1

2 Voluntary trade creates wealth and promotes economic progress With or without production, with or without money exchanges, voluntary trade is expected to benefit both parties involved. Potential trades: 1) Finished goods exchanged through barter 2) Finished goods exchanged for money 3) Businesses buying resources 4) Consumers buying products A transaction cost is a monetary or nonmonetary barrier that lowers the benefits of trade Q2.1 Steve values his car at $4,000, and Jennifer values it at $9,000. If Jennifer buys it from Steve for $7,000, which of the following is true? 1. Steve gains $3,000 of value, and Jennifer gains $2,000 of value. 2. Steve gains $7,000 of value, and Jennifer loses $7,000 of value. 3. Steve gains $7,000 of value, and Jennifer gains $6,000 of value. 4. Steve and Jennifer both gain $7,000 of value. The Importance of Property Rights 2 Kinds of Property Rights: (1) Common rights everybody owns it (2) Private rights only one person owns it Q2.2 When private ownership of a resource is clearly defined and enforced, the private owner 1) has little incentive to consider the wishes of others when deciding how to employ the resource. 2) has little incentive to take care of the resource. 3) has a strong incentive to use the resource wisely and to consider seriously the wishes of others when deciding how to employ the resource. 4) has a strong incentive to consume the resource during the period rather than conserving it for future use. 2

3 /15/2011 Property rights change the incentives for individuals Watch video: Stossel Tragedy of the Commons private property Supplemental Video: Stossel- private ownership and conservation (on Blackboard) Q2.3 In the fictitious country of Lebos, the government allows private ownership of pigs but not of cows. If the demand for pork and the demand for beef both permanently increased in Lebos, in the long run, we would expect 1. the population of pigs to rise and the population of cows to fall. 2. the population of cows to rise and the population of pigs to fall. 3. the populations of both pigs and cows to increase. 4. both pigs and cows to become extinct in Lebos unless the government places the animals on the endangered species list. 25% 25% 25% 25% 60 Incentives created by private property rights: 1) Give proper care 2) Conserve for the future 3) Use resources in ways other people value 4) Mitigate possible harm to others Production Possibilities Curve PPC also called PP Frontier Watch video: Cast Away comparative advantage Graph: Watch content video: Macro Chapter 2- creating PPC 3

4 The PPC can shift Graph: Watch content video: Macro Chapter 2- shifting PPC Q2.4 Using a production possibilities curve, a technological advance that increases the amount of output for the same amount of inputs would be illustrated as 1. a flattening of the curve. 2. a movement from one point to another point along the curve. 3. an outward shift of the curve. 4. a movement from a point on the curve to a point inside the curve. 25% 25% 25% 25% Class Activity: Name one thing that would allow Tom Hanks to produce more fire, one thing to produce more food, and one thing to produce more food AND fire simultaneously. Draw three separate PPCs to illustrate. t Trade, Output, and Living Standards Law of Comparative Advantage Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost. Translation: make something you re good at and trade for something you re not good at. Watch video: Made in America- Barre granite (in class) Supplemental Video: Made in America- Barre granite (longer version of above) 4

5 Q2.5 Opportunity costs differ among nations primarily because 1. nations employ different currencies. 2. nations have different endowments of land, labor skills, capital, and technology. 3. nations have different religious, political, and economic institutions. 4. the work-leisure preferences of people vary considerably from one nation to another. Importance of Comparative Advantage Low opportunity cost Comparative advantage Specialization Division of labor Voluntary trade Increased wealth Adam Smith, Wealth of Nations Watch video: Pawn Stars- Best of bartering The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour. Self-sufficiency is the quickest and most absolute path to poverty Economic Organization 5

6 Question Answers: Society s three questions: 1) What to produce? 2) How to produce? 3) For whom to produce? Watch content video: Macro Chapter 2- economic organization Q2.1 = 1 Q2.2 = 3 Q2.3 = 1 Q2.4 = 3 Q2.5 = 2 6