The Homer & Ned Story, the Worksheet for Unit 2:
Economists often use the mental or rhetorical device of analyzing a “Robinson Crusoe” economy. Wikipedia explains:
A Robinson Crusoe economy is a simple framework to study trade in economics. It assumes an economy with one consumer, one producer and two goods. The title “Robinson Crusoe” is a reference to the novel of the same name authored by Daniel Defoe in 1719. The story is that of a castaway who spent 28 years on an uninhabited island near Trinidad, thus appropriate to describe an uncomplicated economic structure with only one actor.
As a concept in economics, it assumes importance due to its ability to simplify the complexities of the real world. The implicit assumption is that the study of a one agent economy will provide useful insights into the functioning of a real world economy with many economic agents….
In the Robinson Crusoe economy, there is only one individual – Robinson Crusoe himself. He acts both as a producer to maximise profits, as well as consumer to maximise his utility. The possibility of trade can be introduced by adding another person to the economy….
The basic assumptions of the Robinson Crusoe economy are as follows:
- The island is cut-off from the rest of the world (and hence cannot trade)
- There is only a single economic agent (Crusoe himself)
- All commodities on the island have to be produced or found from existing stocks
We are going to use this concept to analyze a simple production possibilities curve to learn why two people might trade. Here’s the situation:
Assume that there is a person on relatively deserted island. Let’s call this person Homer. Homer has almost everything available to him that he might want. However, there are two goods that Homer must produce himself using his scarce (limited) resources: bread and beer. Both goods are produced by combining many of the same resources such as grain, heat, water, yeast, and labor. If these resources are limited, then obviously how much bread Homer chooses to produce will reduce the resources available to produce beer. But Homer wants both bread and beer. Here’s a table of Homer’s production possibilities:
Homer’s possible production plans in the Homer Zone:
|If Homer produces this many units of Bread:||Then Homer has enough resources left over to make this many units of Beer|
Now, Homer has a neighbor on a nearby island. His name is Ned. Ned faces the same trade-off choice between Bread and Beer. Ned’s Production Possibilities, however, are different. Ned has different skills (technology) and different quantities of resources, so his possibilities are different. Ned’s production possibilities include:
|If NED produces this many units of Bread:||Then NED has enough resources left over to make this many units of Beer|
Your challenge is to help Homer and Ned live the best possible life they can – which in this case means having as much beer and bread as possible. (doesn’t it always!)
Assumptions you may make for purposes of answering the questions:
- Production possibilities curves are linear — in other words, the PPF for each is a straight line, not a bowed-out curve. This means that the trade-off between bread and beer (the opportunity costs) for each, Homer and Ned, stay the same regardless of where they are producing on their respective PPC’s
- Initially, Homer and Ned only produce for their own individual consumption. In other words, Homer consumes what Homer produces and Ned consumes what Ned produces. In later questions we may allow trade to occur.
- No stealing or giving of gifts. In an effort to improve Homer’s well-being, we are ruling out the possibility of theft from Ned (Ned has a big shotgun!) or of a gift (Ned isn’t really that nice).
Questions (you enter your answers in the Learning Management System for your school):
- What is Homer’s opportunity cost of producing 1 unit of beer? (give a numeric answer using one decimal place and assume it is in “units of bread”)
- What is Ned’s opportunity cost of producing 1 unit of beer? (give a numeric answer using one decimal place and assume it is in “units of bread”)
- Who has absolute advantage in the production of bread? Homer, Ned, or neither? (enter only one word)
- Homer wants to produce 6 units of bread and 8 units of beer. Is this production plan efficient, inefficient, or impossible? (enter just one word answer)
- Suppose Ned plans to produce 14 units of bread and 14 units of beer. Is this point on, above, or below the PPF curve? (just enter one word)
- Who has the comparative advantage in producing bread? Homer, Ned, or neither? (just enter one word)
- Homer decides to produce 7 units of bread, consume 6 of them and offer to trade the 7th bread to Ned for some beer. What is the minimum amount of beer Homer needs to get from Ned to be at least as well off as Homer was before the trade? (numeric answer with one decimal place)
- Ned is considering Homer’s trade offer. Homer has proposed making 7 units of bread, keeping 6 and giving 1 unit to Ned in return for some beer. What is the maximum amount of beer Ned would be willing to “pay” for this unit of bread? (numeric answer with 1 decimal place)
- Ned and Homer have reached an agreement. Homer will produce 9 units of bread, keep 6 of them and trade 3 units to Ned. Homer will produce beer with rest of his resources. Ned decides to only produce 9 units of bread and increase his beer production to the limit of his remaining resources. Ned trades 4 beers to Homer in trade for the 3 units of bread. What is the “price” of beer in this trade? In other words, for somebody who is acquiring beer, how much bread do they give up per beer acquired?
- Ned and Homer have reached an agreement. Homer will produce 9 units of bread, keep 6 of them and trade 3 units to Ned. Ned decides to only produce 9 units of bread and increase his beer production to the limit of his remaining resources. Ned trades 4 beers to Homer in trade for the 3 units of bread. Following the trade, who is now able to consume a combination of bread and beer that is above their own PPF curve? Homer, Ned, both, or neither? (enter only one word)
- An opportunity cost is a trade-off. When you are producing the most you can (you are on the PPC curve) and you want one more of one good (say good A), you must reduce production of the other good by some amount (call it good B). The amount of B you give up in order to produce one more unit of A is the opportunity costs.
- Since the PPC’s here are assumed linear, this means the opportunity cost is constant for Homer and Ned respectively. In other words, if the opportunity cost of producing another 1 beer was giving up 4 units of bread (it’s not for either of them), then the opportunity cost of producing 2 more beers is exactly 2 times the opportunity cost of 1 beer.
- “Comparative Advantage” means being able to produce a good at a lower opportunity cost when compared to another producer.
- “Absolute Advantage” means being able to produce something with lower resource cost (not opportunity cost). Usually, someone with absolute advantage in the production of one good can simply out-produced in total numbers the production of the other. Someone can have absolute advantage over another in the production of both goods.
- When comparing two producers and two goods, a single producer cannot logically have the comparative advantage in both goods.