Economics Chapters 3, 25, 33-34 Chapter 3 Interdependence and the Gains of Trade Exports Goods produced domestically and

d sold abroad Imports Goods produced abroad and sold domestically Absolute Advantage The ability to produce a good using fewer inputs than another producer Measures the cost of the goods in terms of the inputs required to produce it Two countries gain from trade when each specializes in the good it produces at lowest cost Comparative Advantage The ability to produce a good at a lower opportunity cost than another producer Absolute advantage is not necessary for comparative advantage Gains from trade arise from comparative advantage (differences in opportunity costs). When each country specializes in the goods in which it has a comparative advantage, total production in all countries is higher, the worlds economic pie is bigger, and all countries can gain from trade. Example:

Long Test 3 Reviewer

The U.S. has 50,000 hours of labor available for production, per month. Producing one computer requires 100 hours of labor. Producing one ton of wheat requires 10 hours of labor.

Economics Chapters 3, 25, 33-34

Long Test 3 Reviewer

Economics Chapters 3, 25, 33-34 Chapter 25 Production and Growth Facts: There are vast differences in living standards around the world. There is also great variation in growth rates across countries. Productivity The average quantity of goods and services produced per unit of labor Output (Y) = Real GDP = Quantity of output produced Physical Capital per worker (K/L) The stock of equipment and structures used to produce g&s is called [physical] capital, denoted K. Human Capital per worker (H/L) The knowledge and skills workers acquire through education, training, and experience Natural Resources per worker (N/L) the inputs into production that nature provides, e.g., land, mineral deposits Some countries are rich because they have abundant natural resources. But countries need not have much N to be rich. Technological Knowledge (A) Societys understanding of the best ways to produce goods and services. Technological progress means any advance in knowledge that boosts productivity (allows society to get more output from its resources)

Long Test 3 Reviewer Technological Knowledge and Human Capital Technological knowledge refers to societys understanding of how to produce goods and services. Human capital results from the efforts exerted by people to acquire this knowledge. Production Function A graph or equation showing the relationship between inputs and outputs Y = A F(L, K, H, N) A shows the level of technology F( ) is a function that shows how inputs are combined to produce output. Constant Returns to Scale o Changing all inputs by the same percentage causes output to change by that percentage o Example 2Y = A F(2L,2K, 2H, 2N) Y/L = A F(1, K/L, H/L, N/L) o This equation shows that productivity (output per worker) depends on: The level of technology Physical Capital per worker Human Capital per worker Natural Resources per worker Saving and Investment Increasing K will reduce consumption Reducing consumption = increase savings o Extra savings fund the production of investment goods

Economics Chapters 3, 25, 33-34 Diminishing Return and Catch-Up Effect If the government implement policies to support investment and saving, then K will rise, causing productivity and the standard of living to rise as well Diminishing Returns to Capital o As K rises, the extra output from an additional unit of K falls

Long Test 3 Reviewer finance by foreign money but operated by domestic residents Helps poor countries learn state of the art technologies developed in other countries

Education Construct and support public schools, subsidized loans for college Investing in H involves a tradeoff between the present and the future o Spending a year in school requires sacrificing a years wages now to have higher wages later. Health and Nutrition An investment in human capital Healthier workers are more productive

The Catch-Up Effect o The property whereby poor countries tend to grow rapidly than rich countries

Property Rights and Political Stability Property Rights o The ability of people to exercise authority over the resources they own When there is a fear of breaking property rights because of corrupt government or security, the standard of living decreases because of less investments and inefficient economy. To achieve economic stability, efficiency, and growth, the laws should be enforced properly and there should be effective courts, a stable constitution and honest government officials.

Investment from Abroad Encourage foreign direct investments A capital investment that is owned and operated by a foreign entity Encourage foreign portfolio investments A capital investment 4

Economics Chapters 3, 25, 33-34 Free Trade Inward Oriented Policies o Aim to raise living standards by avoiding interaction with other countries o Examples Tariffs Limits on investment from abroad Outward Oriented Policies o Promote integration with the world economy o Example The removal of restrictions on trade or foreign investment Trade has similar effects as discovering new technologies it improves productivity and living standards Countries with inward-oriented policies have generally failed to create growth Countries with outward-oriented policies have often succeeded Research and Development Knowledge is a Public Good o Ideas can be shared freely, increasing the productivity of many Policies to promote technological progress: o Patent Laws o Tax incentives or direct support for private sector R&D o Grants for basic research at universities

Long Test 3 Reviewer Population Growth may affect living standards in three different ways: Stretching natural resources o Living standards still increased o Technological progress and productivity growth should be taken into consideration Diluting the Capital Stock o Bigger population = higher L = lower K/L = lower productivity & living standards. o fast pop. growth = more children = greater strain on educational system o Countries with fast population growth tend to have lower educational attainment Promoting Technological Progress o More people means more scientists, inventors and engineers which could lead to more frequent discoveries thus resulting to faster technological progress and economic growth o Evidence from Michael Kremer: Growth rates increased as the worlds population increased More populated regions grew faster than less populated ones Natural Resources As a resource becomes scarcer, its market price rises, which increases the incentive to conserve it and develop alternatives.