Econ 201 1st Edition Lecture 6Outline of Last Lecture 6.Production Possibilities Frontier1.Beef and wheat example.Outline of Current Lecture 1.Beef and wheat example~~2.Anlaysize and find answer exampleCurrent LectureComparative Advantage - Comparative advantage lies with the resource having the lower marginal opportunity cost. Thus Flat has comparative advantage in Wheat (2/5 < 1/2) and Hilly has it in Beef (2 < 2.5). Absolute Advantage is different. This refers to superior productivity. Thus the Flat country has absolute advantage in both commodities, because it has superior productivity in both (2 vs. 1 for Beef and 5 vs. 2 for Wheat) Comparative Advantage can be related to Absolute. In this example, the Flat country is more productive in both goods, but it is “more” more productive in Wheat. i.e. Flat is twice as productive in Beef, but it is 2.5 times more productive in Wheat. Thus it has Comparative Advantage in Wheat. Principle of Comparative Advantage Resources should be allocated where they have a comparative advantage.Thus Flat country should specialize toward Wheat and Hilly country toward Beef. This means in trading that Flat would export Wheat and import Beef, and Hilly would export Beef and import Wheat. These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Trade in the Beef & Wheat ProblemTerms of Trade - TOT: rate of exchange between the commodities.How many units of beef do we get for a unit of wheat? (Flat country perspective) How many units of wheat do we get for a unit of beef? (Hilly country perspective)Use two money prices to make a relative price: PW / PB = TOT in units of Beef/unit of Wheat Or:PB / PW = TOT in units of Wheat/unit of Beef′ex. Suppose PW = $45/ton PB = $100/hwt. Then:TOT = 45/100 = 0.45 0.45 hwt. (45 lbs.) Beef per ton of Wheat Or: TOT = 100/45 = 2.2 tons of ′Wheat per hwt. of BeefPreferencesSuppose the Hilly community must have 100 tons of W and then wants as much B as possible. Suppose the Flat community must have 45 hwt. of B and then wants as much W as possible. What should they do? Specialize where they have Comparative Advantage and then trade.Why?Because they can both reach a higher Standard of Living.Limits to the Terms of TradeTrade that arises between these two countries (or any producing units that seek to engage each other in exchange) must be mutually beneficial. This implies that the Terms of Trade (TOT) defined by either money prices or direct barter must lie between the two MOC’s. So here we have:In hwt. of Beef per ton of Wheat:MOCF(W) = 0.40 < TOT = 0.45 < 0.50 = MOCH(W)Or, in tons of Wheat per hwt. of Beef: MOCF(B)=2.5>TOT =2.2 >2.0=MOCH(B)′If the Terms of Trade were outside these ranges, one or the other country would decline the trade offer and produce both goods while facing of their internal production tradeoff, because itwould be more
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