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1. INTRODUCTION
One implication which arises from the modelling of scarcity is the principle
of specialisation & trade.
That is, the outcome after specialisation & trade will be that at least some
will be better off & no one will be worse off.
Consider 2 individuals (the heads of households I & II) who produce all
their life necessities by themselves.
Assume that these necessities include only 2 types of goods: food (F) &
clothes (C).
The second individual (Individual II) can produce either 6 units of clothes
or 6 units of food, or any combination of these two.
Mapping out the combinations of those points will give us the PPF for each
household:
Figure 1: Household I
6
Figure 2: Household II
6
6
1
3
AII
AI
PPF0
1
PPF0 II
Suppose now that the two individuals chose to produce & consume at
points AI = (1, 3) & AII = (3, 3) respectively. The two individuals have
organized their households in a productively efficient manner.
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 1
The total output from both economies is 6 units of clothes & 4 units of
food.
How many units of food will they be willing to give up in order to obtain
those units of clothes?
Household I will not be willing to buy food for more than 3 units of clothes
per unit of food, because they can produce it by themselves at that price
without specialisation.
Household II will not be willing to sell food for less than 1 unit of clothes,
because this is their opportunity cost of producing food without
specialisation.
To facilitate trade & exchange, the price of a good must be less than the
buyers opportunity cost, but greater than the opportunity cost to the seller.
Sellers Opportunity Cost Price Buyers Opportunity Cost
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 2
Suppose that the agreed price is 2 units of clothes per unit of food, this
exchange rate between clothes & food is depicted by the line with slope 2
in the following two graphs.
C
Figure 1: Household I
Figure 2: Household II
6
CPF0II
6
1
3
BII
AI
AII
CPF0I
PPF0I
PPF0 II
1 2
1.5
4.5
3. ADDITIONAL EXAMPLE
30
30
Figure 4: Friday
1
6
CPF0RC
1
3
CPF0F
20
1
2
BRC
15
BF
15
PPF0F
PPF0F
10
10
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 3
The price of a loaf of bread must be 3 potatoes & the price of a single
potato is 1/3 of a loaf of bread.
4. EXTRA PRACTICES
1. Two economies produce only two goods, X & Y. Economy 1 can produce
either 80 units of Y or 20 units of X (or any linear combination of the two).
Economy 2 can produce either 40 units of Y or 20 units of X (or any linear
combinations of the two). Therefore, there exists no price for which
economy 1 will gain from trading with economy 2. True or false, explain.
2. Two economies produce only two goods, X & Y. Economy 1 can produce
either 2 billion units of y or 4 billion units of X (or any linear combination of
the two). Economy 2 can produce either 4 billion units of Y or 2 billion units
of X (or any linear combinations of the two). If the international price of a
unit of X is one unit of Y, & Economic 1 must have precisely 2 billion units
of Y, both economies will consume the same amount of X & Y as each
other. True or false, explain.
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 4
80
50
PPF1
PPF1
40
40
30
PPF0
10
20
Economy 1
20
10
20
Economy 2
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 5
2. Two economies produce only two goods, X & Y. Economy 1 can produce
either 2 billion units of y or 4 billion units of X (or any linear combination of
the two). Economy 2 can produce either 4 billion units of Y or 2 billion units
of X (or any linear combinations of the two). If the international price of a
unit of X is one unit of Y, & Economic 1 must have precisely 2 billion units
of Y, both economies will consume the same amount of X & Y as each
other. True or false, explain.
PPF1
2
PPF0
PPF1
PPF0
Economy 1
Economy 2
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 6
80
4
0
40
PPF0
PPF0
10
20
20
10
2
0
Economy 2
Economy 1
80
5
0
PPF1
4
0
40
PPF1
30
PPF0
10
20
Economy 1
20
10
2
0
Economy 2
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 7
2
PPF0
PPF0
Economy 1
Economy 2
PPF1
2
2
PPF1
PPF0
PPF0
2
Economy 1
Economy 2
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 8
80
5
0
PPF1
40
4
0
PPF1
30
PPF0
PPF0
10
20
Economy 1
20
10
2
0
Economy 2
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Prepared by Dr. Zhang Jianlin. Copyright: Singapore Institute of Management. Edited by William Tan v.16 Sep 14
Page 9