a Standard model of a Trading Economy Production Possibilities and Relative Supply Assumptions of the model Each country produces two goods, food(F)and cloth(C Each countrys production possibility frontier is a smoo oth curve(IT) The point on its production possibility frontier at which an economy actually produces depends on the price of cloth relative to food, PdP Isovalue lines Lines along which the market value of output is constant Copyright C 2003 Pearson Education, Inc Slide 5-6
Copyright © 2003 Pearson Education, Inc. Slide 5-6 A Standard Model of a Trading Economy ▪ Production Possibilities and Relative Supply • Assumptions of the model: – Each country produces two goods, food (F) and cloth (C) – Each country’s production possibility frontier is a smooth curve (TT) • The point on its production possibility frontier at which an economy actually produces depends on the price of cloth relative to food, PC /PF . • Isovalue lines – Lines along which the market value of output is constant
a Standard model of a Trading Economy Figure 5-1: Relative Prices Determine the Economy's Output Food production, QF Isovalue lines Cloth production, Q Copyright C 2003 Pearson Education, Inc Slide 5-7
Copyright © 2003 Pearson Education, Inc. Slide 5-7 Figure 5-1: Relative Prices Determine the Economy’s Output Q Isovalue lines TT A Standard Model of a Trading Economy Cloth production, QC Food production, QF
a Standard model of a Trading Economy Figure 5-2 How an Increase in the relative price of cloth affects Relative supply Food production, QF W(PC/PE) r、w(PPA2 Copyright C 2003 Pearson Education, Inc Cloth production, @c slide 5-8
Copyright © 2003 Pearson Education, Inc. Slide 5-8 Figure 5-2: How an Increase in the Relative Price of Cloth Affects Relative Supply Q1 VV1 (PC/PF ) 1 Q2 VV2 (PC/PF ) 2 A Standard Model of a Trading Economy TT Cloth production, QC Food production, QF
a Standard model of a Trading Economy Relative Prices and demand The value of an economy' s consumption equals the value of its production PcOc+ PFOF=PCDc+PDF=v The economys choice of a point on the isovalue line depends on the tastes of its consumers, which can be represented graphically by a series of indifference curves Copyright C 2003 Pearson Education, Inc Slide 5-9
Copyright © 2003 Pearson Education, Inc. Slide 5-9 ▪ Relative Prices and Demand • The value of an economy's consumption equals the value of its production: PCQC + PFQF = PCDC + PFDF = V • The economy’s choice of a point on the isovalue line depends on the tastes of its consumers, which can be represented graphically by a series of indifference curves. A Standard Model of a Trading Economy
a Standard model of a Trading Economy Indifference curves Each traces a set of combinations of cloth(C)and food (F consumption that leave the individual equally well off They have three properties Downward sloping The farther up and to the right each lies, the higher the level of welfare to which it corresponds Each gets flatter as we move to the right Copyright C 2003 Pearson Education, Inc Slide 5-10
Copyright © 2003 Pearson Education, Inc. Slide 5-10 • Indifference curves – Each traces a set of combinations of cloth (C) and food (F) consumption that leave the individual equally well off – They have three properties: – Downward sloping – The farther up and to the right each lies, the higher the level of welfare to which it corresponds – Each gets flatter as we move to the right A Standard Model of a Trading Economy