No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Two: Fundamentals of Economic Behavior 54 To see how the gains from trade work in practice, consider two farmers that can produce either corn or wheat. Given that I am most certainly not very knowledgeable about farming, let’s simply assume for whatever reason (equipment, soil conditions, skill, etc.) that one farmer, Jamal, is significantly better at growing wheat, and the other farmer, Sydney, is significantly better at growing corn. Either farmer could grow some of the other crop, as seen in Figure 2.2 . The tradeoff in output is called a production possibilities frontier , or PPF (see below). PRODUCTION POSSIBILITIES FRONTIER (PPF) A production possibilities frontier (PPF) is a way of comparing possible productive outputs of a person or group. It is a natural outcome of scarcity and opportunity cost—to produce more of one good requires the sacrifice of another good (or goods). We will talk much more about PPFs in chapter 6, but for now, we just need to know a PPF illustrates the limiting case of production; we could always be less efficient and produce beneath the curve, but we cannot produce more (at least over the long run) as by definition the PPF describes the best possible productive technique. Jamal could devote all of his efforts towards producing corn, and grow 4,000 bushels of it. Alternatively, he could grow 10,000 bushels of wheat. Sydney could likewise choose to produce 4,000 bushels of wheat, or 12,000 bushels of corn. Both could choose some linear combination of corn and wheat as in Figure 2.2 . Can you tell who has the lowest opportunity cost and therefore the comparative advantage at producing corn and wheat? The answer is found, as in the previous example, by calculating how much of one good Jamal and Sydney must give up to produce the other. Jamal has a comparative advantage at producing wheat and Sydney has the comparative advantage at producing corn. If Jamal produces only wheat (his comparative advantage) and Sydney produces only corn (her comparative advantage), Jamal would produce 10,000 bushels of wheat and Sydney would produce 12,000 bushels of corn. By trading some of their production for the other good, Jamal and Sydney can both consume more than under autarky . Autarky describes a self-sufficient nation or individual; they don’t trade for anything but produce all of their consumption goods. Compare the autarky output with cooperative trading output in Tables 2.2 and 2.3. Jamal obviously benefits with cooperative trade, as he gets 4,000 more bushels of corn, while keeping the same amount of wheat. Sydney is able to consume 3,000 more bushels of wheat, while keeping the same amount of corn. Both Jamal and Sydney benefit greatly by cooperative trade. And of course this works not just for Jamal and Sydney, but is a universal economic principle. autarky: when all production is internal to the unit (individual or state) with no trade; the unit is self-sufficient Wheat (kbu) Corn (kbu) 5 10 5 10 Consumption without Trade Consumption with Trade Jamal Sydney Figure 2.2, Bill & Jane’s Production Possibilities Frontier (PPF). Bill and Jane each can produce corn and wheat, but both face tradeoffs according to the PPFs above. Jane has a comparative advantage in producing corn, while Bill has a comparative advantage in producing wheat. If they each produce according to their comparative advantage, they can both consume more. production possibilities frontier (PPF): a PPF illustrates the tradeoff between two goods given a fixed amount of productive inputs; more of one good necessarily reduces the production of the alternative good