Prelim 1 Flashcards
What is Adam Smith’s Second Insight?
given different national prices, it makes sense to specialize in production.
What is Adam Smith’s First Insight?
national price differentials, in and of themselves, provide incentives to trade between countries
Absolute Advantage
producing a product more (most) efficiently
e.g. at
lowest absolute cost
−
compared to other countries or producers.
Opportunity Cost
the number of units of one good you must sacrifice to get
one additional unit of another good.
Comparative Advantage
producing a good with lower or lowest opportunity
costs of production.
Specialization
the use of resources to produce some, but not all, goods
required by society.
Autarky
trade equilibrium point
Terms of Trade
relative prices of a country’s exports and imports: P
X
/P
M
What happens when a country has an absolute advantage (e.g. lowest cost) in neither product or no product?
David Ricardo (early 19 th century): even in this case, trade and specialization can occur due to the principle of comparative advantage
What was David Ricardo’s Insight?
same incentives to specialize and trade exist, even though one country has an absolute advantage in both products
What is Globalization?
Begin with a basic economic perspective − the reduction and elimination of traditional barriers which separate international buyers and sellers: 1. Decreasing transportation costs 2. Decreasing transactions costs 3. Trade policy barriers: tariffs, quotas, etc. 4. Market - determined exchange rates
Globalization levels the competitive playing field (“the world is
flat”
–
T. Friedman)
But, there is still asymmetric information, imperfect markets,
market power, and major institutional flaws (IMF) (
Stiglitz
)
Production Possibilities Frontier
curve showing all possible combinations of outputs of two products that a producer (or economy) can produce with resources fully employed and the best available technology
Marginal Rate of Transformation
the amount of one product that a
producer (or economy) must sacrifice in order to produce one more unit of
another commodity (also the
slope of the production possibility frontier at
the point of production
)
MRT = Slope of PPF
Marginal Cost of Production (MC)
cost of producing an incremental unit of a good or service ( equivalent to MRT between 2 goods – e.g., what you give up of one good to get more of another)
what happens if marginal costs are constant – what does the Production Possibility Frontier look like?
Linear PPF
What happens when we allow
trade and specialization
with constant
(for now) marginal costs?
Each country produces and consumes along a linear
(constant marginal cost) Production Possibility Frontier
Decreasing marginal costs
most likely to occur in
industries with ______________ ?
Decreasing marginal costs most likely to occur in industries with significant economies of scale
In what industries are economies of scale most likely to occur and why?
Utilities industry (electricity, natural gas,
water, etc.)
–
why?
Capital intensive, large initial fixed investment
Low transactions costs for marginal nth consumer
What is more common, increasing marginal costs, or decreasing marginal costs?
Increasing Marginal Costs
Why do Increasing Marginal Costs occur?
At some point as production increases, marginal
costs of production increase due to costs of:
training and educating workforce
physical infrastructure to expand, reduce
bottlenecks
marketing
higher pay to induce labor supply
Comparative Advantage Vs. Competitive Advantage
Comparative advantage: Based on production costs (e.g. opportunity costs) and factor endowments.
”Competitive advantage”: (Michael Porter)
Based on:
• Firm strategy and structure
• Consumer demands
• Supporting industries (agglomeration economies)
• Specialized factor conditions
