Investigate incentives for trade and the basis of trade:
Comparative advantage
Absolute advantage
Understanding Economics
Definition: Economics is the study of choices made by individuals and societies to fulfill unlimited wants with scarce resources.
Economists analyze how decisions are made regarding work, purchases, savings, and investments.
Study interactions between buyers and sellers to determine price and quantity sold.
Scarcity
Key Concept: Scarcity occurs when unlimited wants exceed available limited resources.
Example: Allocating waking hours among studies, work, and social activities demonstrates scarcity of time.
Macro and Microeconomics
Key Concept:
Macroeconomics studies the aggregate effects of individual decisions within an economy.
Microeconomics focuses on the individual decision-making principles within the economy.
Principle 1: People Face Trade-offs
Scarcity leads to making trade-offs in resource allocation.
Example: Dividing time between studying, socializing, and working.
Trade-offs illustrate the need for rational allocation of scarce resources to maximize economic well-being.
Efficiency and Equity
Efficiency: Maximizing output from resources without waste.
Taxpayer expectations of efficient resource use.
Equity: Fair distribution of economic prosperity.
Example: Taxation can redistribute wealth, increasing equity but potentially decreasing efficiency.
Principle 2: Cost and Opportunity Cost
The true cost in economics is the opportunity cost, defined as the value of the next best alternative forfeited.
Principle: The cost of something is what you give up to get it.
Economic Models
Economists use models comprising diagrams and equations to analyze real-world issues and propose solutions.
Assumptions simplify complex situations to focus on key details.
Production Possibility Frontier (PPF)
Key Concept: The PPF graphically represents different output combinations that can be produced with available resources and technology.
Example: PPF can illustrate trade-offs in producing goods, such as computers and cars.
PPF Graph Features
Point B: Inside the frontier indicates inefficiency.
Point D: Outside the frontier is unattainable.
Moving from Point C to Point A represents an opportunity cost of trading 200 computers for 100 cars.
Technological advancements can shift the PPF outward, increasing potential outputs.
Consumer Goods vs. Capital Goods
Consumer Goods: Used for personal satisfaction (e.g., smartphones, refrigerators).
Capital Goods: Used to produce other goods and services (e.g., delivery trucks, production equipment).
Increasing Opportunity Cost
The PPF is bowed outwards illustrating increasing opportunity costs, where the cost of producing additional units of one good rises when production of the other good is decreased.
Principle 3: Specialization and Trade
Principle: Specialization improves efficiency in resource deployment, resulting in increased outputs that can be traded.
Absolute Advantage: Ability to produce a good using fewer inputs than another producer.
Comparative Advantage: Ability to produce a good at a lower opportunity cost than another producer.
Comparative Advantage Example
Labour Hours Needed:
Amy: 6 hours for cupcakes, 3 hours for pastries.
Kate: 4 hours for cupcakes, 4 hours for pastries.
Identifying who should produce which item based on opportunity costs.
Conclusion
The principle of comparative advantage dictates that goods should be produced by the entity with the smallest opportunity cost.
This principle forms the basis for international trade, though real-world trade includes various complexities.
Homework Assignment
Independently calculate an exchange rate beneficial for both housemates, applying the principles discussed.