Chapter 3: Interdependence and the Gains from Trade
What surprised me most about the concepts in this chapter had to do with comparative advantage and trade. First off, a few brief definitions: Absolute advantage: the ability to produce a good or service at a lower cost per unit than a competitor. Comparative advantage: the ability to produce a good or service at a lower opportunity cost than a competitor. When I came to this sentence in our textbook: "The gains from specialization and trade are based not on absolute advantage but on comparative advantage" I have to say I was taken aback. In my mind I would automatically assume it would be based on some calculation of both, and I was confused as to how and why it would only be based on the one. Alas, after further reading... *ding* - light bulb! Our textbook poses the question "Should Tom Brady mow his own lawn?" in which lies the resolution of my confusion. The example goes something like this: Mr. Brady is capable of mowing his lawn in two hours, while the neighbor boy would do it in four. Mr. Brady has the absolute advantage because it takes him less time to mow the lawn. BUT, in that same two hours, Mr. Brady could instead film a commercial and earn $20,000; and the neighbor boy - in his four hours - could earn $40 working at Mickey D's. Tom Brady's opportunity cost of mowing the lawn: $20,000; neighbor boy's: $40. Accordingly, it's the neighbor kid that has the comparative advantage. *DING!* Now it all makes sense. Of course Mr. Brady should hire the boy to mow the lawn.
Shifting gears... International trade - it's a good thing! Without international trade, a country would be restricted to goods/services produced within its borders, and miss out on the valuable revenue and growth that comes from global trade. International trade also stabilizes seasonal market fluctuations; and it allows for greater efficiency.
"Economic models are used to explain the way the world had worked in the past and predict how it will work in the future. A good model does both accurately." -Author Unknown
Economic models use a simplified version of reality to illustrate complex processes. Too much information while testing theories can be overwhelming - at least for me - so by cutting down the information to a few key components, it's easier to reach a conclusion. And by putting information into a model, it makes it possible to obtain consistent results. For instance with the production possibilities frontier it's much easier to grasp the scope of possibilities when loking at two specific goods as opposed to trying to factor in several goods. The PPF model is a graph that shows a variety of combinations of output that the economy can possibly produce with the resources available at that time. This model makes it seem effortless to understand the concepts of efficiency, growth, opportunity costs and scarcity. It helps me to understand the economy by having an organized visual that lays out the different possibilities. By moving to a different point along the line, it illustrates opportunity cost - what was given up to produce x more units of something else. A point outside of the curve shows where production could be with growth, and inside the curve demonstrates inefficiency. So with that I can boldly say, grasping economic concepts by use of the PPF = SUCCESS! :)
This chapter also talked about positive and normative analysis in the world of economics. A ban on smoking in public places will reduce the tobacco industry's annual revenue. - Positive statement. The government should ban smoking in public places. - Normative statement. Positive analysis refer to descriptive, factual statements whereas normative analysis refers to prescriptive, value-based statements. There's a big difference. ;)
Chapter one: The Ten Principles of Economics. This chapter was a brief introduction of the ten principles, so I can only imagine what is to come as we delve deeper into the world of micro.
Something in this chapter that made me think about an economic concept differently than my previous beliefs was the concept of a short-run trade-off between inflation and unemployment. Now, I admit I am no genius in economics. In fact before studying Principles of Macro I had very limited knowledge on the subject. But before even knowing the theories or terms, I have been a believer in "the invisible hand," so trying to see the positive side of government control has always been a bit challenging for me. However I do find it interesting to open up my perspective and entertain new ideas. According to short-run trade-off between inflation and unemployement when inflation is high, unemployement is low and vice versa. The government/Federal reserve manipulates the money supply: if a lot of money is printed, government spending is increased, taxes lowered, etc. it stimulates the economy and reduces unemployement but leads to inflation in the long run. On the contrary, if the money supply is retracted, government spending cut, taxes raised, it would raise unemployement but reduce inflation in the long run. Mathematically, this seems logical. I guess when it comes to "controlling" our economy I just need a little more convincing. I suppose I'm still a believer of letting the marketplace self-regulate. Old fashioned idea to some, I know.
New questions I have after reading this chapter would all have to do with monetary policy, mostly because I don't know too much about it. I wonder just how often these policies are put into effect; monthly, daily, hourly? And also, are they really working?
"...but if daddy raised your allowance he'd be hurting the economy by stimulating inflation. You wouldn't want him to do that, would you?"
