so this is our first video of the semester and which we'll talk about chapter two and there will be a couple more videos for this week as well also about chapter two um and i just wanted to kind of show you the setup that we're going to use for the semester so i have a white board behind me here and i'm planning to use this regularly throughout the videos and i hope that it kind of makes us feel like we're in more of a typical classroom setting and to go with each video there will be another document or some portion of another document with some notes and some space in there for you to to add your own notes as well my hope is that you can use those documents to follow along with the videos and i hope that all together it kind of gets us out of the monotony of using slides for example so i'm not going to use i'm not playing to use slides um as of now and we'll see how this goes and hopefully it makes us all feel a little bit more like we're in a usual classroom setting and i think uh for me that's definitely what i prefer and so i'll show you now the document that goes along with the video that we're going to go over so here's the document that goes with the first video today and you'll see there are some notes in here i just have it labeled at the top this is for chapter two it's the first video and this will be should be posted up on canvas throughout the semester i'll put the the notes up on canvas that go with each video so let's go ahead and get started and i'll i'll probably switch back and forth a little bit between this document and using the board but in general i'll probably want to spend most of time on the board but this document should hopefully help you follow along as we go through the video so today we're going to talk about economic models trade-offs and trade and so we're discussing chapter two and first of all i think it's good to think about what we're referring to when we say model so when we refer to a model we're just referring to some simplification of reality and we're going to use these models to help us learn about the way people interact with firms at some point we're going to think about or use them to discuss how economic policies might influence people's actions or outcomes in different markets but in general we're just taking some simplification like super simplified version of reality so that we can hopefully learn something about behavior today what we're going to discuss is called a production possibilities frontier and the production possibilities frontier describes a set of possible combinations or bundles of goods that some producer could make and we're going to drop our first ppf in a minute on the board now as we're drawing that up though this is kind of how we can think about it we're going to draw this for just some generic two goods x and y um and this ppf will describe um all the possible combinations but the actual line of the pbf itself will tell us that if we have or if we produce some level of x what's the most amount of y that we can produce in addition to that level of x and hopefully this will become this will become a little more clear as we go through the drawing i left some space here in the notes so that if you want you can draw an example of ppf here as well so we're going to draw our first ppf here that stands for production possibilities frontier and i'll probably refer to it as ppf more often than not so let's imagine that we have two goods here and we're just going to do sort of the most generic thing that we can to start so we have goods x and y and we'll put good y on the y axis and good x on the x axis and what the ppf is going to tell us so imagine we have some producer who is potentially going to produce some amount of y and some amount of x the ppf is going to tell us all the possible combinations of x and y that this producer could produce and so to start let's just think about if the producer decides to only produce y then they would produce whatever maximum level of y they could possibly produce by using all of their effort and resources to produce y and so the y-intercept here is their maximum amount of y that they could produce if they decided to produce no y and put all their effort and resources in producing x then they would end up with the most possible x that they could produce and the x-intercept would tell us the maximum that maximum of x that they could produce so i put a a note in the example here in the description or the instructions that we're going to consider a ppf where the trade-off is constant and so what do we mean by that well what that means is that regardless of how much x or y this individual is producing or what point they're producing at they would always have this to give up the same amount of x to increase the production of y or they'd have to get the same amount of y to increase the production of x that trade-off is constant regardless of where they're operating at so another way to say that is that this ppf has a constant slope or it's a linear ppf so what that means graphically is that we're just connecting the intercepts so the ppf itself describes possible bundles where if we know the level of production of one good then the corresponding point on the ppf tells us the most of the other good that they could produce so in other words think about this point this tells us a combination or think about the level of y here for example we'll say y is zero this tells us the maximum y this person could produce if x equals x0 and we'll just call this x0 so if this person decides to produce x0 the most y they could produce would be y 0 and that should give us a point on the ppf which i'll just call point a so in that sense the ppf describes what we might think of as efficient combinations and when i say efficient i mean the term efficiency in production which we have written below the space here and that's because if we choose some other point that's not actually on the ppf so let's think about some other point let's just take for example this point here you'll notice that at this particular point which i'll call point b this bundle of goods that this person may or may not want to produce and gives them x 0 but then it also gives them what i'll call y sub 1 which is less y than y sub 0. so because it requires resources to produce x and y and we know that this individual based on their ppf could produce this combination of y zero and x zero point b is inefficient in the sense that um they could increase production of y they could also increase production of x but the way i drew it it's just really clear about why here they could increase their production of y without having to sacrifice any amount of x and so this is an example um for pointing this out hopefully makes it clear that point b is inefficient point a is efficient because it's on the ppf and if we wanted to consider a third point let's take i'm just going to draw some point c out here notice that based on the definition that we gave to this actual ppf line it describes the maximum amount of one good that they could produce if we know the level of the other good but this point out here point c is outside of that ppf so we know that the the producer could produce point b because that producing point b requires fewer resources than producing point a but on the other hand they could not feasibly produce point c because to get more x and y requires more resources and since it's outside of the ppf this means that they don't actually have enough resources to produce point c so while point c might be desirable because they might like x and y point c is not feasible so this is uh this describes or tells us about efficiency in production what we haven't talked about yet is there's a different concept listed somewhere in here called efficiency and allocation uh it's just it's at the start of the second page here efficiency and allocation so efficiency and allocation would be about where on the ppf so we've established that all these points on the ppf are both feasible and they are efficient in production because they're using all of the resources they don't have any idle resources like they would if they decided to produce a point b but we haven't said anything about how the producer or society might decide which point is more preferable than another and today we're mostly going to focus on uh feasibility here um and with that in mind let's think about comparing different points that are on the ppf and so i will um start over here uh and remove some of this from the from the figure we're going to go over more concrete examples if you don't like using the x and y terminology i just want to do the most generic thing first but we are going to have some examples here where we use different goods and name the producers and i think for some people that might be more more tangible so we thought about what's what's feasible what's infeasible what's efficient what's inefficient in production now let's think about moving along this ppf for or what happens if they are deciding between two different points on this ppf the sort of the decision that the producer is facing trade off we have x and y we have some producer who could make a maximum amount of y which we can find by the y-intercept if they put all their resources toward producing x then the x-intercept would tell us how much x they'd end up with and we said this is linear so we'll just connect the dots so we earlier had up some point somewhere up here which we call point a which we said is both feasible and it's efficient in production because they're using all of their resources available but there are a bunch of other points that are also on the ppf here so let's just pick some other point point b it's different from the point b we talked about earlier which was somewhere inside the ppf this point b is also feasible because it's on the ppf and it's also efficient in production because they're using all our resources to get to point b they're not they don't have any idle resources so when we're deciding between points a and b we have to we face some trade-off and the way we can see this is we have some bundle of goods that we can produce at point a and i'll just put y 0 y 1 x 0 and x 1. if we are making this decision between point a and point b say that imagine we're producing a point a and we're considering going to point b instead we have two things that happen here right we have to give up some amount of y we're gonna go from y zero to y 1 but the benefit is that we increase our level of x we go from x 0 to x 1. so this is the trade-off the opportunity cost of moving from a to b is that we have to give up some level of y this is the trade-off that the producer is facing there is a benefit but then there's also some cost so i think as we move through an example here maybe this will also become more clear how we can think about this and write out this problem um for this producer and then after that we're we're going to compare the options for a couple of different producers and think about how they might be able to engage in some trade that might make them better off so in our example here we have a producer who is tom amber and the producer tom could make i said a maximum of 30 coconuts or 40 fish so tom is stranded on a on an island all by himself and so he can use his resources his effort to produce two things fish and coconuts and so using what we just talked about with the ppf we could draw tom's ppf based on the information given in this example here so the important piece is here and let's draw it out we'll put coconuts on the y-axis and we'll just put fish on the x-axis and the most maximum number of coconuts that tom could produce if that's all he cares about or all he wants to produce is 30. so this intercept on the coconut axis is 30. if tom only produces fish he would end up with 40 fish and so that's his intercept on the fish axis another piece of information here is that the trade-off is constant in other words the ppf is is linear and so we're just connecting the dots here and this is tom's ppf so um using this ppf um you know we talked earlier about potential things that are feasible which are on the ppf or under the ppf um but if we don't produce all the ppf then we're inefficient in production we can produce outside of the ppf that's infeasible we don't have enough resources to produce those bundles and we're going to focus in this example on different points that are on the ppf and so the first thing i want to talk about is what are tom's opportunity costs of producing fish and coconuts so one way to figure out the opportunity cost so ultimately what we want to know is if tom wants to increase his production of fish by one unit how many coconuts would he have to uh give up on the other hand if he wants to increase his production of coconuts by one unit how many fish would he have to give him so one way to get to the answers here is to think about it this way tom can produce 30 coconuts or he could produce 40 fish if i want to know the opportunity cost of coconuts then i want to get a 1 in front of the c here in other words it will tell me i wrote this as an equation but really what we're saying is um the amount of fish you could produce in total is 40 or coconuts in total is 30. and so that is a trade-off right there right if he wanted to produce 40 fish you'd have to give up 30 coconuts for example if we produce 30 coconuts you have to put 40 fish but we want to get these in terms of one unit and so if we rewrite this by dividing by 30 we'd say that c equals four thirds f so in other words every time tom wants to increase his production of coconuts by one unit you'd have to give up four thirds of the fish so this tells us the opportunity cost of coconuts now if we did this the other direction and we wanted to get a one in front of the f from the fish it'll tell us the opportunity cost of fish i mean you'll notice that we just have a single producer here who's making two goods and so we're just dividing by 40 instead of 30 in other words the opportunity cost of fish will be the reciprocal of the opportunity cost of coconuts so if tom wants to increase fish production by one unit he would have to give up three-fourths of a coconut and that's what we mean by opportunity cost you might also notice that the second one here has is or both of these in some way are related to the slope of this ppf right because when we're thinking about this trade-off between producing some number of coconuts or some some number of fish and moving along this line then that trade-off has to be closely related to the slope and you might notice in this case the slope of this ppf is equal to negative 3 over 4 which is the negative of the opportunity cost of fish so next i'd like to add a second producer to the problem so and in the next part you think tom runs into another person hank who is also on the island and hank like tom can use his effort to produce coconuts and fish as well but his ppf looks a little bit different than tom's and so let's think about um how they're they compare to each other uh first let's just discuss hank's ppf and think about hank's opportunity costs um as well so i'm going to erase most of this here this is tom's ppf and we'll come back to drawing tom's ppf along with hank's ppf in a little bit but for now let's just think about hank's ppf so hank is also producing coconuts and fish so the two axes are the same here but for hank if he produces only coconuts so this is in the in the setup to the problem in the document here that goes with the video if hank produces only coconuts he'll end up with 20 coconuts and if hank produces only fish he'll end up with 10 fish and again we have a constant slope a linear ppf here and so hank's ppf looks something like this now if we want to think about the opportunity cost for hank of producing coconuts and fish we can follow same same steps so we know that hank can produce either 20 coconuts or 10 fish so if we think about what hank has to give up to produce one coconut divide by 20 he has to give up one half of a fish so this would be opportunity cost of coconuts on the other hand if we think about this in the other direction divide by 10 instead we'd say that if he wants to produce one fish he'd have to give up two coconuts so this would be the opportunity cost of fish and again you'll notice there's the relationship right between the slope here so the slope of this ppf is the negative of the opportunity cost of fish and if you think about why that is the case maybe start by thinking about a scenario where hank decides to produce 20 coconuts and zero fish and then think about what happens if hank wants to increase his fish production so if hank is at 20 00 or 020 here and he wants to increase fish production by one right so he wants to move out to this point so to increase fish production by one unit by one fish he would have to decrease coconut production by two so that's where we get this opportunity cost from and that gets us back to another point on the ppf so it's feasible it's efficient in production and that's why we end up with a slope of negative two that's also equal to the opportunity cost for for fish and again remember that there are just two goods here for this producer to choose between so the opportunity the opportunity cost of producing one good is the reciprocal of the opportunity cost of producing the other good so next i want to use these two producers in this example that we've built up here to talk about two concepts absolute advantage and comparative advantage so i've redrawn up the the two ppfs we these are both uh what we drew earlier for tom and for hank so remember we just used the idea that we were given the maximum amount they could produce of each and also we were given the fact that they are both linear so the slopes are constant and we use that to draw the ppf for tom he could produce 30 coconuts or 40 fish and hank who could produce 20 coconuts or 10 fish so now we want to introduce two new concepts here one the first one is called absolute advantage so absolute advantage uh belongs to the producer who could produce more of of a good so let's think about this so in other words if you want to determine who has absolute advantage and production of some good just think about who is who could produce more who's more productive at producing that that good so let's compare the maximum amount of coconuts that hank could uh produce compared to the maximum coconuts that tom could produce well hank can produce if he spends all of his effort and resources producing coconuts he ends up with 20 coconuts but if tom spends all of his effort on resources producing coconuts he ends up with 30 coconuts and so to figure out who has the absolute advantage just ask ourselves who would produce more if they both both focus on that production that good so absolute advantage and production of coconuts would be tongue which my tongue has absolute advantage and production of coconuts and we could do the same exercise for fish production if hank spends all of his resources on producing fish he'd end up with 10 fish and if tom does the same he end up with 40. so again tom has the absolute advantage in production of fish i think that this concept of absolute advantage is probably a little bit easier maybe than comparative advantage but comparative advantage is a really important concept and we're going to use it to determine um or to talk about trade after we figure out who has the comparative advantage or production of each good so let's talk about comparative advantage so to figure out who has comparative advantage in production of each good we want to ask ourselves who can produce that good at a lower cost who can produce that good at a lower cost um so what we mean by cost well we talked about opportunity costs earlier right if tom wants to increase coconut production he has to give up some fish so that represents a cost of coconut production if he wants to uh produce some fish he has to go some coconuts so that's the cost of coke of fish production and hank has the same face as a similar type of trade-off although we saw that their opportunity costs are not the same and another way to say that opportunity costs are not the same right is that the slopes of these two ppf's are not the same so i think one way or um i think it might help a little bit to write this out in table form and just think about who has opportunity or what the opportunity cost is for each producer for each good and i put a table in the document here and i'm just going to write up a similar table here on the board so we have tom and hank and we want to know their opportunity cost of production for each good so for a fish and coconuts and we already actually wrote these down earlier as we were walking through the example and we found that for tom his opportunity cost for fish was three-fourths of a coconut i think this can get a little bit confusing because the opportunity cost for producing one good fish in this case is written in terms of the other good and so i know it's difficult to keep track but um that that is part of the model here right because if we move along this ppf the cost that we have to pay to increase fish production is that we have to give up some coconuts and so that's part of the setup to the model here and we also found earlier that if hank wants to increase fish production hank would have to give up two coconuts in order to produce one fish so hank's opportunity cost of fish is two coconuts continuing along with um we wrote these down earlier but just kind of going over how we got there again if we wanted to figure out uh tom's opportunity cost of coconut production we we could do it the way we did earlier but now that we know his opportunity cost for fish production we also figured out earlier that his opportunity costs for producing the other good is just the reciprocal of that one so for tom his opportunity cost of fish production is three-fourths of a coconut which means his opportunity costs for coconut production is four-thirds of the fish and similarly we know that for hank since his opportunity cost of fish production is two coconuts his opportunity cost for coconut production is one half on the fish now back to thinking about comparative advantage so we wanted to write down all of these opportunity costs that's what we have here this table of opportunity costs because it's going to help us to determine who has comparative advantage and production of each good so again uh comparative advantage is all about who can produce at a lower cost and so looking at this table let's just focus on one good at a time so if we think about the cost for each producer of fish production we'll see that tom's opportunity cost is three-fourths of a coconut but hank's opportunity cost is two coconuts and so the lower of the two is the three-fourths of a coconut which means that comparative advantage of fish production belongs to tom now let's focus on coconut production hank's opportunity cost is half a fish toms is four thirds of the fish so the lower of the two the lower cost belongs to hank so hank has the comparative advantage in coconut production so earlier we found that tom had absolute advantage in production of both goods which just meant that he could produce more but even though he has absolute management production in both goods he has comparatively managed only production of one of the goods that in the two producer two good case they will always each have compare advantage in one of the two goods as long as the slopes of the ppf's are different and that will always be true because the opportunity cost of production of one good is the reciprocal of the other and so if one producer has a lower cost and production of one good then they're going to have a higher cost in production of the other good and that just comes out of the model because the cost of one is giving up production of the other good so next now that we know who has the comparative advantage and production of each good let's think about how these two producers might use this idea of comparative advantage um and think about potentially specializing the production of some good and then maybe even trading after they specialize in production so to finish up our video our first video i want to think about how we can use this information to think about specialization and trade so um the first uh first thing to note here is that specialization is dictated by comparative advantage so if we ask ourselves um let's just kind of um assume that we're going to have them specialize and then we'll see later why we want them to specialize but for now let's just say we think we want them to specialize in production of of one good or the other which good should they specialize in well that's completely determined by who has comparative advantage and which good so because tom has the comparative advantage and production of fish then we would say that tom should specialize in fish production and what do we mean by specialized so as they go about specializing what do we mean by specializing exactly since tom has compared advantage of fish production we would say that tom produces we're making this as extreme as possible tom spends all of his effort producing fish so town produces 40 fish and that's what we mean by special design specialization in this example and since tom's spending all his effort producing fish he's not going to produce any coconuts at all but hank is also going to specialize and he's going to specialize in coconut production for which he has the comparative advantage and so if he spends all of his effort producing coconuts uh hank would end up producing 20 coconuts okay now let's imagine that they make this decision they specialize in production of two different goods on tom and producing fish and hank and producing coconuts and then let's just imagine that they decide to trade after they specialize so in total we have 40 fish which tom produced and 20 coconuts but let's say they make some deal they make an agreement where they trade 10 for 10. so in other words because hank has all the coconuts after they specialized hank gives up 10 of his coconuts in exchange for 10 of tom's fish so in the end let's think about what bundles each of the two would have to consume so tom started out by producing 40 fish but then he gave up 10 of those so he has 30 fish total and he received 10 coconuts in exchange so he has 30 fish and 10 coconuts hank on the other hand started out by producing 20 coconuts but then he gave up 10 in exchange for 10 fish so hank has 10 fish and 10 coconuts now let's think about um how those bundles compare with the ppf's for tom and hank and i'm just going to focus on hank yeah so let's just think about hank's ppf on its own here for a minute we know that hank is going to consume after they specialize and they trade he's going to have 10 fish and 10 coconuts now let's focus back on hank's ppf for a minute and think about how that consumption bundle corresponds or relates to his ppf here so let's find a point on hank's ppf where he consumes 10 coconuts so this point on hank's ppf of 10 coconuts would correspond to consuming how many fish i wanted to give you a minute to think about it but now of course probably consuming five fish so one way to see this would be to write out the equation for the line for hank's ppf or you could think about hank's trade-off that he faces that we described earlier so as hank increases his fish production by one unit he has to give up two coconuts so he gives him two coconuts at a time all the way until he gets down to ten he would only have five fish total so we're just using the slope of this ppf to figure out that point so if we compare that with the bundle that hank will consume when they specialize in trade we found that he would be able to consume remember 10 fish and 10 coconuts so that's a point all the way out here outside of hank's ppf so remember earlier when we talked about this a point like this that's outside of the ppf we said that that's infeasible and if hank is limited to producing all of the goods he consumes on his own this would be infeasible because he wouldn't have the resources um he wouldn't have the resources to actually produce all of these goods on his own so the only reason that he's able to get to this point is because the two individuals agreed to specialize and then trade after they specialize so i left a couple of um questions i left a couple of questions in the uh you could do something similar as well for for tom's pdf as well and his bundle and find that it should be outside of his bundle as well part of the reason that worked and the few questions at the bottom here that i'm hoping will help you answer those questions will hopefully help you see why this works well i chose a price a one-for-one price that kind of set this example up to work that way right so this price is something that is beneficial to both producers so think about the price uh well let's just pick one producer first we talked about hank earlier so let's think about hank after they specialized and traded hank was able to was able to get he specialized in coconut production so he was able to get a fish by giving up one coconut but if he wanted to produce a fish he'd have to give up two coconuts so that price that one for one price is beneficial for hank it's it's much cheaper to trade for that one-to-one price than it is for him to actually produce the fish himself now look at the other the other producer tom tom started out by producing 40 fish if he's left up to uh his if he's the only producer and he's left up to uh enough to do all the production himself and he wants to increase his coconut consumption he can only do that by reducing uh fish that he produces the amount of fish produces but he'd have to give up four thirds of a fish so by specializing in trading he only has to give up one fish in order to receive a coconut so again for tom it's actually worthwhile at this one-to-one price or wonder for him to specialize and then trade afterwards so part of the reason it works out is because of the price i i chose but nevertheless there are always going to be prices in a setup an example like this there will be some trade-off where they're both willing to make the trade and it makes them better off and leaves them outside of their ppf but part of the key here is that the two producers have different opportunity costs of producing each good and so that's critical if the slopes of the two ppf's are the same then they wouldn't have different opportunity costs and it would change the problem a bit but this is um the first example that we go over in the semester because this concept of comparative advantage and thinking about trade is really important um for economics and with that in mind we're actually going to go over another example but in the next video i will have a different document which is just an example for um for the problem and then i'll go over the problem here on the board in the next video