Part%I%

Compara+ve%Advantage%&%%
the%Basis%for%Trade
%

"Playconomics,"LHS"

"Playconomics,"LHS"

Your"First"Model"
Deni+on:%%
A"Model"is"a"simplied"representa<on"of"reality."

"Playconomics,"LHS"

Your"First"Model"
Assump+ons%
"

There"are"only"
There"are"only"
When"trading,"there"are"

."
."

(nego<a<on/transporta<on"
costs),""
(import"quotas,"taris)."

David"Ricardo"in"1817""
magic"4"numbers"
"Playconomics,"LHS"

"Playconomics,"LHS"

A."One"Agent"Economy"
"

(Assump<on"1):"

collec<ng"bananas"and"catching"rabbits"
"

Performing"an"ac<vity"involves"use"of"
1kg"bananas"takes"1"hour"to"collect"
1kg"rabbit"takes"2"hours"to"catch"
"

The"amount"of"resources"used"to"perform"a"
produc<ve"ac<vity"determines"produc+vity%
"Playconomics,"LHS"

A."One"Agent"Economy"
%
!"oWen"we"operate"in"a"
constrained"environment"(i.e.,"nancial%
constraints,"+me%constraints)"

Albertos"<me"constraint:""
24h/day"Z"8h"sleep""="16h"

"Playconomics,"LHS"

A."One"Agent"Economy"
Step"1:"

"

16h"collec<ng"bananas""
!"16kg"bananas"(16h"x"(1kg/1h))"
!"0kg"rabbit"

16h"catching"rabbit""
!"0kg"bananas"
!"8kg"rabbit"(16h"x"(1kg/2h))"
"

"Playconomics,"LHS"

A."One"Agent"Economy"
Step"2:"

"

16h"collec<ng"bananas"AND"rabbits"
!"8h"x"(1kg/1h)"="8kg"bananas"
!"8h"x"(1kg/2h)"="4kg"rabbit"
!"4h"x"(1kg/1h)"="4kg"bananas"
!"12h"x"(1kg/2h)"="6kg"rabbit"
!"1h"x"(1kg/1h)"="1kg"bananas"
!"15h"x"(1kg/2h)"="7.5kg"rabbit"
"
"Playconomics,"LHS"

A."One"Agent"Economy"
Step"3:"

and"create""
Produc+on%Possibility%Curve%

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
The"Produc+on%Possibility%Curve%represents"all,
possible,combina0ons"of"bananas"and"rabbits"
that"can"be"produced"with"Albertos"labour"if"he"
works"all,the,available,hours,(i.e,"the"whole"day)."

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on%(general):%%
The"Produc+on%Possibility%Curve%captures"all,
maximum,output,possibili0es"for"two"(or"more)"
goods,"given"a,set,of,inputs,(or"resources"Z"i.e.,"
<me)"if,inputs,are,used,eciently."

"Playconomics,"LHS"

A."One"Agent"Economy"

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
The"Produc+on%Possibility%Curve%represents"all,
possible,combina0ons"of"bananas"and"rabbits"
that"can"be"produced"with"Albertos"labour"if"he"
works"all%the%available%hours%(i.e,"the"whole"day)."
"if"all"inputs"(or"resources)"are"used"eciently"
(no"<me"to"waste)!!!"
"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
An%Ecient%Produc+on%Point%represents"a"
combina<on"of"goods"(bananas"&"rabbits)"for"which"
currently"available"resources"(Albertos"<me)"do%not%
allow%an"increase"in"the"produc<on"of"one"good"
without"a"reduc<on"in"the"produc<on"of"the"other."
All,the,points,on,the,PPC,are,ecient.,

"Playconomics,"LHS"

A."One"Agent"Economy"

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
An%Inecient%Produc+on%Point%represents"a"
combina<on"of"goods"(bananas"&"rabbits)"for"which"
currently"available"resources"(Albertos"<me)"allow"
an"increase"in"the"produc<on"of"one"good"without"a"
reduc<on"in"the"produc<on"of"the"other."All,the,
points,below,and,to,the,le=,of,the,PPC,are,inecient.,

"Playconomics,"LHS"

A."One"Agent"Economy"

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
An%AGainable%Produc+on%Point%represents"any"
combina<on"of"goods"(bananas"&"rabbits)"that"can"
be"produced"with"the"currently"available"resources"
(Albertos"<me)."All,the,points,on,the,PPC,or,below,
and,to,the,le=,of,the,PPC,are,a>ainable.,

"Playconomics,"LHS"

A."One"Agent"Economy"

"Playconomics,"LHS"

A."One"Agent"Economy"
Deni+on:%%
An%UnaGainable%Produc+on%Point%represents"any"
combina<on"of"goods"(bananas"&"rabbits)"that"can%
not"be"produced"with"the"currently"available"
resources"(Albertos"<me)."All,the,points,that,lie,
outside,of,the,PPC,are,una>ainable.,

"Playconomics,"LHS"

A."One"Agent"Economy"

"Playconomics,"LHS"

A."One"Agent"Economy"
What"if"
higher
%

"Playconomics,"LHS"

B."Two"Agents"Economy"
"

:"

collec<ng"bananas"and"catching"rabbits"
"

Performing"an"ac<vity"involves"use"of"
1kg"bananas"takes"1"hour"to"collect"
1kg"rabbit"takes"2"hours"to"catch"

Consump+on%needs:"4kg"of"rabbit"&"9kg"of"bananas"
(clearly"unahainable!)"
"Playconomics,"LHS"

B."Two"Agents"Economy"
Remember:%4%rabbits+9%bananas%
=%unaGainable%

"Playconomics,"LHS"

B."Two"Agents"Economy"
2

:"

collec<ng"bananas"and"catching"rabbits"
"

Performing"an"ac<vity"involves"use"of"
1kg"bananas"takes"4"hours"to"collect"
1kg"rabbit"takes"4"hours"to"catch"

"
"

"produc<ve"for"16h"per"day""
"Playconomics,"LHS"

B."Two"Agents"Economy"
Leos"

"

16h"collec<ng"bananas""
!"4kg"bananas"(16h"x"(1kg/4h))"
!"0kg"rabbit"

16h"catching"rabbit""
!"0kg"bananas"
!"4kg"rabbit"(16h"x"(1kg/4h))"

Consump+on%needs:"7kg"bananas"(clearly"
unahainable!)"

"Playconomics,"LHS"

B."Two"Agents"Economy"
Note:%7%bananas%=%unaGainable%(Leo)%

"Playconomics,"LHS"

B."Two"Agents"Economy"
Can%Leo%help%Alberto%achieve%%
his%consump+on%target?%

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"
Deni+on:%%
An"agent"(or"an"economy)"has"an"Absolute%
Advantage%in"a"produc<ve"ac<vity"(like"collec<ng"
bananas"or"catching"rabbits)"when"he/she"can"
carry"on"this"ac<vity"with"less"resources"(i.e.,"less"
<me)"than"another"agent.,
"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"
Opportunity%Cost!%

"Playconomics,"LHS"

B."Two"Agents"Economy"
Deni+on:%%
The"Opportunity%Cost"of"a"given"ac<on"is"the"
value"of"the"next"best"alterna<ve"to"that"
par<cular"ac<on.",

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"
Opportunity"Cost"made"(super)easy:"
OC%=%slope%of%the%PPC%!!%
%
"
""""""""""""""""""""""""% % % %%%%%%%%%%OCbananas%T%Alb%=%%
% %%
% %

% %% % %% % %% % %% % %% % %% % %% %=%(8/16)kg%rabbit%
%% % %% % %% % %% % %% % %% %%%%%%%OCbananas%T%Leo%=%%
% % % % % % % % % % %%%%=%(4/4)kg%rabbit"
"Playconomics,"LHS"

B."Two"Agents"Economy"
Opportunity"Cost"made"(super)easy:"""""""""""""""""""""""""
%%%%
OCbananas%=%(loss%in%rabbit/gain%in%bananas)%
%
OCrabbit%=%(loss%in%bananas/gain%in%rabbit)"
"

"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"
Deni+on:%%
An"agent"(or"an"economy)"has"an"Compara+ve%
Advantage%in"a"produc<ve"ac<vity"(like"collec<ng"
bananas"or"catching"rabbits)"when"he/she"has"a"
lower%opportunity%cost%of"carrying"this"ac<vity"
than"another"agent.,
"Playconomics,"LHS"

B."Two"Agents"Economy"

"Playconomics,"LHS"

B."Two"Agents"Economy"

+1kg%
+1kg%

Gains%from%
specializa+on%%%
"Playconomics,"LHS"

B."Two"Agents"Economy"
Principle%of%Compara+ve%Advantage:%%
Everyone"is"beher"o"if"each"agent"(or"each"country)"
specializes"in"the"ac<vi<es"for"which"they"have"a"
compara<ve"advantage."The,gains,from,
specializa0on,grow,larger,as,the,dierence,in,
opportunity,cost,increases!,

,
"Playconomics,"LHS"

B."Two"Agents"Economy"
Now"were"ready:"

%
YES!%IF%%
Z ALBERTO%SPECIALIZES%IN%BANANAS%&%%
Z LEO%SPECIALIZES%IN%RABBITS%&%
Z THEY%TRADE!%BUT%AT%WHAT%PRICE?%
"Playconomics,"LHS"

B."Two"Agents"Economy"
THEY"TRADE!"BUT"AT"WHAT"PRICE?"
%

Alberto"specializes"in"bananas"!"will"want"to"sell"to"Leo"at""
pricebananas""Albertos"cost"of"collec<ng"bananas"OR"
"pricebananas""Albertos"OCbananas(=0.5kg"rabbit)"
%

Leo"specializes"in"rabbits"!"will"want"bananas"as"long"as""
Pricebananas""Leos"cost"of"collec<ng"bananas"himself"OR"
Pricebananas""Leos"OCbananas"(=1kg"rabbit)"

0.5kg%rabbit%%pricebananas%1kg%rabbit%
%
%

"Playconomics,"LHS"

C."Economy"PPC"in"TwoZAgent"Economy"
"

Find"the"total"amount"of"rabbit"that"Leo"&"Alberto"can"produce"if"
they"spend,all,their,0me,catching,rabbits,
Start"producing"bananas""Alberto"1st"kg"(why?)"
Con<nue"to"produce"bananas"(exhaust"Alberto"and"only"then"
move"to"Leo""why?)"
Find"the"total"amount"of"bananas"that"Leo"&"Alberto"can"produce"if"
they"spend,all,their,0me,collec0ng,bananas"

"Playconomics,"LHS"

C."Economy"PPC"in"TwoZAgent"Economy"
"

PPC%is%a%curve%bowing%
out%from%origin%
SLOPE?%

"Playconomics,"LHS"

C."Economy"PPC"in"TwoZAgent"Economy"

Albertos%PPC%slope%(1)%
Leos%PPC%slope%(>Albertos)%(2)%

"Playconomics,"LHS"

C."Economy"PPC"in"TwoZAgent"Economy"
Principle%of%Increasing%Opportunity%Cost%
(Low%Hanging%Fruit):%%
In"the"process"of"increasing"the"produc<on"of"any"
good,"rst,employ,those,resources,with,the,lowest,
opportunity,cost"and"only"once"these"are"exhausted"
turn"to"resources"with"higher"cost.""

"Playconomics,"LHS"

C."Economy"PPC"in"TwoZAgent"Economy"
Principle%of%Increasing%Opportunity%Cost%
(Low%Hanging%Fruit):%%
In"the"process"of"increasing,the,produc0on,of"any"
good,"rst,employ,those,resources,with,the,lowest,
opportunity,cost"and"only"once"these"are"exhausted"
turn"to"resources"with"higher"cost.""

,
Need"to"have"

"Playconomics,"LHS"

:"

C."Economy"PPC"in"TwoZAgent"Economy"
The"main"factors"driving"
(i.e.,"
push"the"economy"PPC"out"and"to"the"right)"are:"
"

"""in"
"!"factories,"equipment,""
"""in"
"!labour"force,"
Advancements"(")"in"
!"educa<on,"R&D,"IT,"communica<ons"tech."

"Playconomics,"LHS"

D."Trading"Between"Economies:""
Why"Trade?"
"
A"countrys"
does"not"depend"on"what"it"produces"(PPC),""
but"on"what"it"consumes"(CPC)!"
"
Consump+on%Possibility%Curve%(CPC)"

"Playconomics,"LHS"

D."Trading"Between"Economies:""
Interna<onal"Trade"
Deni+on:%%
The"Consump+on%Possibility%Curve%represents"
all,possible,combina0ons"of"two"goods"that"the"
agents"in"an"economy"can"consume."
PPC%%%Vs%%CPC"
"Playconomics,"LHS"

D."Trading"Between"Economies:""
Interna<onal"Trade"
"

"Playconomics,"LHS"

D."Trading"Between"Economies:""
Interna<onal"Trade"
Deni+on:%%
The"Consump+on%Possibility%Curve%represents"
all,possible,combina0ons"of"two"goods"hat"the"
economy"can"feasibly"consume"when"it"is"open"
to"interna<onal"trade.""
"
depends%on%interna+onal%(world)%prices"
"Playconomics,"LHS"

D."Trading"Between"Economies:""
Interna<onal"Trade"
Say"1kg"bananas"="0.2"rabbit"(interna<onal"world"price)"

"Playconomics,"LHS"

D."Trading"Between"Economies:""
Interna<onal"Trade"
(no"trade)"""
"""""""!"PPC%and%CPC%are%iden+cal"
(trade"on"the"intern."market)""
"""""""!"CPC%is%to%the%right%and%above%the%PPC%%
"

Consump+on%opportuni+es%in"an"open"economy"are"always"wider"
than"in"a"closed"one!"
"

What"should"an"economy"consume?"DEPENDS!"

"

Needs%&%Wants%=%Preferences"

"Playconomics,"LHS"

E."EconomyZwide"PPC"in"a""
ManyZAgent"Economy""
"

"
Everything%we%discussed%so%far%s+ll%applies!%%

"Playconomics,"LHS"

E."EconomyZwide"PPC"in"a""
ManyZAgent"Economy""
"
Curve%bowing%out%
from%origin%
SLOPE?%

"Playconomics,"LHS"

E."EconomyZwide"PPC"in"a""
ManyZAgent"Economy""
"
Because%PPC%is%a%smooth%curve%we%must%
calculate%the%slope%IN%A%POINT!%
Slope%is%increasing!%What%does%this%mean?%

"Playconomics,"LHS"

E."EconomyZwide"PPC"in"a""
ManyZAgent"Economy""
"

Slope%is%increasing!%What%does%this%mean?%
OC%of%bananas%in%terms%of%forgone%rabbits%
is%increasing!%

"Playconomics,"LHS"

F."Classic"Cri<ques"to"the"Model""
We"assumed""

associated"to"performing"the"same"
ac<vity"the"en<re"day"!"Boredom"doesnt"kill"you!"
connected"with"trading"(i.e.,"
nego<a<on"costs,"transporta<on"costs,"etc)"
!"would"limit"the"gains"from"
specializa<on"by"making"specializa<on"(beyond"a"certain"
level)"pointless"
for"goods/services"in"which"a"
country"specializes"in"and"no"accoun<ng"for"social"norms"
that"might"prevent"trading"
"Playconomics,"LHS"

"Playconomics,"LHS"