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Gains from Exchange

North Island

This simplified example illustrates the gains from voluntary exchange or trade:

North Island is a good place to make crepes. It is not impossible to make Nuttella ™ , but the geography makes it very difficult, so most people have to eat just crepes every day.

South Island

South Island is a good place to make Nutella. It is not impossible to make crepes, but if people in the South used all their labor and capital to produce one food, they could make much more Nutella than crepes.

The opportunity cost of making crepes is the number of jars of Nutella they could have made with those same resources.

The South has a comparative advantage in making Nutella over making crepes. Therefore, most people in the South can only eat Nutella.



Each island can increase its total output by specializing, however they would prefer to consume these two foods in a more equal proportion. They will both be better off if they trade.

Crepes AND Nutella






If you are reading this on a computer, you are experiencing the gains from trade.  If you did not build this computer yourself from what you could hunt or gather in nature by yourself, you  traded for it.… Read More

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Food trade is an important part of economic history.  Europeans literally sailed across the world to spice up their dinners, and they stumbled across the Americas in the process.  Here are some good resources to learn more:

How the Spice Trade Changed the World

Lecture Slides from Oregon State

Adam Smith, who is considered one of the founders of economic thought, argued against the European “mercantilism” ideology.  Mercantilists believed that a country should export more than it imports because that would bring in gold.  Smith criticized government polices that were restricting trade in order to maintain a “favorable balance of trade.”  He advocated for free trade laws allowing countries to export the goods they have an advantage in making and import what is relatively more expensive for them to make.

David Ricardo formulated the theory of comparative advantage 200 years ago. In my little example, that is the idea that one island can produce Nutella more efficiently than the other island, so they have a relative advantage.

Around the same time, Thomas Malthus gave his gloomy prediction that, as the human population grows, we will run out of land to grow noms, and then people will starve (if they are not killed by war or disease first).

The human population has since increased far beyond Malthus’s wildest dreams. We are able to do that because:
1. The earth does not grow along with the economy and population.  Since there is only so much land to grow food on, we increase our output through new technology that allows us to get more noms out of our limited resources.
2. Increased specialization and exchange. Ex. People in Kansas can get oranges from Florida in exchange for wheat.

International food trade policy remains an important topic of debate today.… Read More

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Non-Zero-Sum Games

To understand non-zero-sum games, it is helpful to give an example of the opposite: a zero-sum game.

Here’s a fun game: “stealing your older brother’s ice cream”

The little brother is unhappy because he has no ice cream, so he has a utility score of -1. “Utility” is a term economists sometimes use to roughly measure happiness.

The older brother is happy because he has ice cream, so he has a utility score of 1.

Together, their collective welfare is equal to 0.

After a change in the allocation of goods, their total welfare has not increased, it is still zero.

In a zero-sum game, the total amount of wealth remains the same and it is just a question of how you divide up a fixed pie, or ice cream cone.







In a NON-zero-sum game, the choices people make actually affect the total wealth in the system.  I will illustrate this with the crepes-Nutella environment in the Gains from Exchange chapter.

Let’s say that, due to sea weather conditions, each island can only send one boat on the first day of every month, and they will not know if the other island sent a shipment of food until that boat arrives two days later.  So, on the first day of each month, both islands have two strategies to chose from: { send, don’t send }.

Economists sometimes present these games using a payoff matrix:

North Island
Send Don’t Send
South Send 6, 6 2, 7
Don’t Send 7, 2 3, 3

The pair of numbers {x, y} in each box represent what the {South, North} would earn for each decision set.

If neither chose to send, they both are stuck with boring food.
3+ 3 = 6

If North island sends food and South island does not, the South will be better off but the North will have less noms than before.
7+ 2 = 9

If both chose to send, they will both get to enjoy delicious crepes with Nutella, resulting in an increase in total welfare.
6 + 6 = 12Read More

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This actually came up on

Text: BUY YOUR HAPPINESS FOR FREE!  We will tell you which penny stocks can rise up to 2100%, for free!

1.) Can you buy happiness?  2.) Can you buy anything “for free?”  3.) Can any stock potentially rise up to 2100%
$69 Replica Watches for MenRead More

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Donuts and Convex Preferences

When I recently brought home donuts, my roommates decided we should fry them.  Yes, donuts have already been fried.  Double-fried donuts.  Om Nom Nom.

(You can click on these pics to enlarge them.) In the first picture: donuts going into the deep frier. In the third picture, you can see a healthy dinner of baked salmon and sweet potato with sauteed asparagus.

This illustrates our “convex preferences.”

Our household prefers more food to less food. So, we would rather have 20 pounds of food in the fridge than 15, because 20 15.

However, our happiness is not just a function of the pounds of food in our house. We would not want ONLY donuts, even though we like them. We prefer to consume food in combinations. For example, a salmon dinner followed by a double-fried donut.

So, we would chose 15 lbs of a mix of foods instead of 20 lbs of just donuts.

The principle of convex preferences is an important part of the theory of consumer behavior. The math is explained nicely by wikipedia. … Read More

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When making cookies, it’s difficult to not eat all the cookie dough before cooking it. However, if you exert will power, preheat the oven, and exercise patience, you will get perfect warm cookies that are worth the wait.

For both individuals and societies, waiting is an important part of becoming wealthy. If you can afford to wait and make smart investments, you can trade consuming something today for consuming even more in the future.

You can invest money in a new business so that they have the start-up capital they need to become a profitable company. They will pay the amount of the loan back with interest because it cost you something to not spend the money right away.

Another way to invest is to buy something and then sell it for a higher price. Typically we don’t do this with noms because they depreciate quickly (a.k.a. get nasty in the back of the fridge)… but it happens all the time in the stock market.

Another method of investment is to buy commodities, such as gold or oil. The value of gold goes up and down, but less suddenly than most stocks. Savy gold investors are able to use sites such as BullionVault to monitor the value of their investment, and to trade online. Buy low. Sell high. … Read More

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Informative Posts on Economic Topics

Here is an excellent resource, especially for understanding the monetary system and its relation to the Great Recession. More

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If Chef Kitteh has no competitors, then no one can get cookies without coming to her. She can set any price, although a higher price will mean that less people will buy cookies because the market demand curve for cookies slopes down. Gustav would give up anything for cookies, but even he is constrained by his budget.

For any supplier who has the recipe, the marginal cost of producing each cookie might be as low as 50 cents. In a competitive market, no producer could charge much more than 50 cents because customers can choose to buy cookies somewhere else at a lower price. If Chef Kitteh has a monopoly on cookies, she will pick a price that maximizes her profit, which may be well above 50 cents.

The result will be less noms for everyone and higher prices. Chef Kitteh makes profits as a monomnomopolist… probably going to be eating tuna every night.

(credit student Luke Markham for “monomnomopoly”) … Read More

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