Transcription
Hi class. So now we are continuing on with chapter two. Uh, this will be the second video of two for this chapter. Uh, the last thing we covered was our uh bowed out production possibilities curve, which indicated specialization of inputs, as well as the law of increasing relative cost. And now we're going to go on to continue to use the production possibilities curve to talk about economic growth.
So economic growth is essentially where we can increase the production possibilities of both goods A and B, and of course, this occurs over a period of time. So caterer's paribus is for one PPC. So to show economic growth, we're going to need two, because we're going to show one snapshot in time going to the next. And then of course, economic growth is displayed by an outward shift of the PPC.
So essentially, looking at the trade-off between the present and the future, we're going to use the PPC to illustrate the trade-off between present and future consumption. And this is much like the lesson of our personal lives. How do we behave with our income? Do we save or do we consume a lot of it? Obviously, if you save more, you'll have more to consume in the future. If you consume a lot of it now, then you're going to have less to consume in the future because you didn't prep yourself for savings. And essentially, this is what the lesson is between this PPC example here.
So using the PPC to show where we can have, instead of producing apples or basketballs, we're choosing two different activities of how we can spend our time. For C, we're going to be consuming. For K, we're going to be spending our efforts, uh, building physical capital. And physical capital is something that, again, resources, things that can be used to produce other things. The physical capital is something that will increase our capability of consumption. One way to look at it is if you are stuck on a desert island, uh, let's just say that you could consume, which, for example, you could consume fish. So you could fish and eat what you catch, or you can build physical capital, which might be a fishing net. So you could spend your time on the island doing one of those two activities: fishing and eating, or building a net to catch fish in the future. So that's one way you can look at the C and the K component.
Okay, so, uh, choosing this situation here, suppose we had a scenario where we spent a great deal of our efforts, or whatever, our time consuming. And what happens there is that we have a relatively smaller amount of physical capital built up. So if we were to look at, you know, what I'm just going to superimpose it on this diagram, if we were to look at the amount of increase in the next period, let's say that it might be something like this. So we did experience some growth. Okay, now this one is associated with C1 and K1. Okay. On the other hand, suppose we chose a situation where we decided to consume less at C2 and we spent more time building physical capital to increase our consumption in the future. So in that case, instead of having the PPC here, maybe we'll have a PPC now out here. And this PPC is going to be based on consumption level two, therefore physical capital two. We've built out more. So we have one possible growth path and another possible growth path. This one has a greater amount of physical capital. This one has less amount of physical capital, so less savings, less consumption in the future. So that's essentially using the production possibilities curve with consuming consumer goods as well as physical capital goods to kind of make an example of how you spend your time and what it implies in terms of the trade-off between present and future consumption.
So continuing along in the vein of increasing productivity, thereby increasing consumption potential, we're going to talk about another aspect of increasing productivity into the concept of specialization. Now, specialization is the division of productive activities, and this leads to greater productivity. And essentially, we're going to be looking at two different types of advantages and, uh, deciding how to make our determination of who specializes in which activity. If we have two goods that we can do, such as, you know, maybe on a desert island example again, either fishing or gathering coconuts, two activities and two people who could, one person could fish and the other person could gather coconuts. How do we determine who should specialize in which activity? So we can have greater consumption based on this idea.
So we're going to look at two possible concepts of advantage. One is absolute advantage. And absolute advantage is the ability to produce more units of a good or service using a given quantity of resource inputs. That's missing a word in there. Supposed to say the ability to produce more units of a good or service using a given quantity of resource inputs. And another type of advantage is comparative advantage. Comparative advantage is the ability to produce a good or service at a lower opportunity cost. This comparative advantage is based on, it's a relative concept because it has to be compared to someone else for us to make a decision. And then we specialize in the production for which we have a comparative advantage. So that's the rule. When you determine comparative advantage, that's how you can determine who specializes in which. Okay, so if you have the lower opportunity cost in an activity, then you would specialize in that activity.
Okay, so let's go ahead and continue along with that desert island example. Okay, so imagine this, you're two people and you're stuck on a desert island, and you have a couple of activities that you can do to determine, uh, how you're going to survive. And one is gathering coconuts, and another one might be gathering fish, like we mentioned. Okay, and so there's my fishing pole and so forth. Okay, so the situation is, we're trying to determine who should spend their activity, spend their time doing which activity.
So let's just say then that we have the two people. One is, uh, we have me. We'll make me one of the people here, and you the other person. And the two activities we can do is gathering coconuts, or we could fish. Okay, so we're going to work on our production possibilities curve. And remember, on the axis, the extreme points on the axis means you're devoting all your effort to that one activity. So on the coconut side of the axis, so let's just say if you're looking at the PPC like this, you have coconuts, and then you have fish on the other side. And then of course, it's going to be a negative slope that represents the trade-off. You do one, you sacrifice another. And that's why you have a negative slope here, like that. So anyway, if I spend all my time gathering coconuts, let's just say I can gather 12 coconuts. On the other hand, if I spend all my time catching fish, let's just say I can catch eight fish. You, on the other hand, if you spend all of your time gathering coconuts, it turns out that you can gather 14. And if you spend all your time fishing, you can get seven. Okay, so this situation here is sort of like setting it up where for me, with coconuts and fish, it would be something like 8 and 12. And there's my PPC. And you, on the other hand, with coconuts and fish, you would be doing 14 and seven. Okay. Uh, didn't matter if I do the straight line. I didn't mean to make a bowed out and straight. It was. And well, let's just back that up then. How's that? So I will do this. There we go.
Okay, um, so now the thing for us to do is to determine who has comparative advantage, who has the lowest opportunity cost in which activity. So let's calculate the opportunity cost of one coconut. If each of us spends our time gathering coconuts, what do we sacrifice for each coconut that we gather? Okay, so we'll work it out this way. We have me and the ratio, the trade-off, the rise over the run, that, uh, that we could look at. It's going to be minus coconuts relative to fish. And again, that negative simply says that when I pursue one activity, I give up some of the other. So there's that negative concept there. And so here I have minus 12 over 8. Okay. Um, and essentially, what I want to do for that coconut, if I want to figure out my opportunity cost of one coconut, all I gotta do is flip that ratio, minus 8 over 12. And so to gather one coconut, I sacrifice 8 over 12 fish. Okay, so if I were to reduce that fraction, I can say it's going to be minus two-thirds fish. Okay. Um, and then for you, we're going to be looking at that same concept. And so it's going to be 14 over 7. And so in that case, I'm just going to flip the ratio, 7 over 14 fish. So for each coconut you gather, you sacrifice, sorry, I forgot the negative, minus one half fish. Okay, so in this case, you have the lowest opportunity cost in gathering coconuts. You sacrifice the least amount of fish. Therefore, the rule is that you specialize in coconuts. And if we wanted to find it for the opportunity cost of one fish, well, then you just flip the ratios and then you recalculate it. And you're still going to come out with the same idea, irrespective of how the ratios work out. You're going to end up specializing in coconuts, even if we're looking at the opportunity cost of one fish instead of one coconut. We'll still come out with the same result and who has comparative, the lowest opportunity costs in which activity and therefore who should specialize in which activity. And when we get that correct, then generally we would be experiencing an increase in output and thereby an increase in consumption.
Okay, so that pretty much wraps up the main ideas that I think needed a little, if any, guidance. But I think you guys were probably fine without this, but I just wanted to make sure regarding some points that might have been potentially sticky. And I hope that gives you enough to continue on and wrap up chapter two homework set. And of course, please feel free to email us with questions regarding this. And of course, include both your TA and myself, and one of us will get back to you. Or you can, of course, schedule a personal, personal meetings or come into our drop-in hours that we have set and announced. Anyway, take care, everybody. Stay healthy. And I will look forward to talking to you guys soon. Aloha.