One morning the Econ family saw a number of boats approaching their island. Presently, 10 couples with their children would arrive the island and these humgry, feeble and sick group was surprised to find Econ family receving them. These group had lost their way in the storm and were without food and water for weeks before they reached the shores of Wonderland. In a few days they would recover to normal health, thanks to the hospitality and care of the Econ family. They decided that it was not possible for them to go back to their own lands as they had no idea where the Wonderland was located in relation to their orginal home land and in any case they were driven out from their homeland by the rulers. They had to set up new home in Wonderland. But the land in this island was claimed by Econ family. The Econ family agreed to sale some land to each of the ten families. But how would they pay the Econ family; they had nothing with them to offer. So, it was decided that they would pay the Econ family over the next five years out of the produce they generate using the land they would now purchase. Price was fixed at F20,000 for each piece of land.
How was the price arrived at? Econ calculated that if they would employ each family to gather fruit from each plot of land they would have plucked enough fruits to feed and shelter them and have a surplus of about 2000 fruits per year surplus to give to Econ family as rent for the land. Econ thought 10 years' land rent could be fixed as the price of land.
One of the families, the Marx family, decided to rent out the land and pay 2000 fruits per year, while the other families decided to buy the land. But how could they pay. They would also pay over a period of five years. Since they would be paying over a period of time, they would have to pay more than 20,000 fruits. It was decided that they would pay F5277 fruits annually for the next five years. In a sense, each of the family took a loan of F20,000 from Econ family and agreed to pay back with interest of 10% per year on reducing balances. The equated annual instalment on that basis worked out to 5277 fruits.
However, all the families demanded that all fruits are not of equal value because they would taste differently and weigh differently and should not be priced at F1 a piece. It was a big problem. It was decided that the price of the fruits would depend on the market as the fruits are bought and and sold. It was decided also that a standard bag filled with apples would be priced at F10 for conveniece to start with. No rotten or damaged fruit would be bought and sold in the market. The prices of other fruits will be determined in relation to the price of apples depending on demand and supply in the market: that is to say that the jackfruits containing the same standard bag could be higher or lower than F10. The same would be true of all other fruits.
In order to facilitate the exchange of goods among the families it was decided that the Ekon family issues some currency F. The Ekons agreed to issue 1100 F1 paper notes with the signature of EKON & Wonder. Each family including Ekon family were issued 100 notes. The 10 new families took these as loans from the ekon family and agreed to repay this small loan by selling goods to the Ekon family over the next one year. It was also agreed that the Ekons would not issue any further notes untill all families decided to agree to such a decision.together. So the notes were numbered from 1 to 1100.
With these notes available, the 10 families would pay daily wages to the membes of the Marx family for their labour services and also purchase different goods from each other. And, a new community life bagan in Woderland with paper notes acting as medium of exchange. Soon however Wonderland would give up the system of paper currency. But that is next.
Tuesday, March 30, 2010
Sunday, March 28, 2010
04: Gains From Trade
A few years had passed and Wonder raise a decent size of poultry of chickens. Wonder told Econ, " Just consider that between two of us, we are now able to produce annually more fruits and chickens more to meet our family nees. So, why should we now trade with G-land?" Econ said, " You are right, dear. But let me think over and discuss with G-land couple on this".
Soon they met G-land people by visiting them in their own boat. G-land people also said that they did not want to trade with W-land, because they also had all that they needed. Econ said to himself that if both the countries have become self-sufficient and self-reliant, it was a great thing. So, there is no need to trade now. They stopped trading for a few years till Wonder Economist (Wecon) grew up a bit and started applying his mind.
Wecon talked to his parents as also the parents of his friend in G-land. Then, he did some calculations and produced a chart like this;
W-land maximum capacity to produce was either 10000 fruits, or 5000 chickens, besides 2000 fish in off season spare time., while G-land capacity was to produce 10000 fruits or 6000 chickens. Thus, G-land was more productive than W-land in respect of chickens they were equally productive in fruits. He shared this information with everyone. His parents were a bit disappointed, while his friend's parents were very proud that they were more productive.
Then Wecon told them that this information suggeste that G-land should produce only chickens and W-land should produce only fruits. And that would benefit both the countries. Both sets of parents were perplexed demanded to know how this were possible. Wecon replied as follows. Let us assume that to start with both G-land and W-land produced only fruits. So, each would produce 10000 fruits each. Now, if W-land wants to produce, say 1000 chieckens, it would have to cut fruit production by 2000 (so that they can divert one-fifth of their time and energy from fruit plucking to chicken raising: 10,000 fruit = 5000 chicken or 2000 fruits = 1000 chickens). On the other hand, if G land wants to produce 1000 chickens, they have to divert only one-sixth of their time from plucking of fruits to raising chicken and therefore would have to cut fruit production by 1333 only. This means that in terms of number of fruits foregone/ sacrificed, chicken in costilier in W-land than in G-land. It is in the interest of G-land, therefore to sell 1000 chickens to W-land and buy more than 1333 fruits, say 1500 fruits from W-land which W-land would be willing to do because if they were to produce 1000 chickens themselves they would have to reduce their fruit production by 2000. This means that G-land had a comparative advatage in chicken raising while W-and had comparative advantage in plucking fruits.
This appeared interesting. But the parents demande that Wecon illustrates how they would benefit. So, Wecon continued and said that let both countries to start with allocate half of their time and effort to both chicken and fruits. Then what would be the production scenario? W-land would produce 5,000 fruits and 2,500 chickens. G-land would produce 5000 fruits and 3000 chickens. Total apple production would be 10,000 and chicken production 5500. Now, let G-land produce only chicken and W-land only fruits. Total production would be 10,000 apples entirely by W-land and 6000 chickens entirely by G-land. Thus there is a net gain 500 chickens in total production and no loss in fruit production For both the countries. Now, W-land sells 5000 fruits to -land in exchange for 2750 chickens. So both of the countries are better off now: Both countries continue to have 5000 fruits each as before, but G-land has 3250 chickens instead of 3000 chickens and while W-land has 2750 chickens instead of 2500 chickens. So instead of producing both fruits and chickens they should specialise in the production of that in which each has comparative advantage.
Everyone understood how trading contributed to gains to both the countries. The international trade between the two countries resumed: annually, G-land sold 2750 chickens to and bought in return 5000 fruits (price of a fruit was thus equal to 0.55 chicken or price of a chicken is 1.8 fruits approximately).
Since G-land produced chickens only, their GDP was 6000 C (chicken as currency unit), or 10,800 F . W-land GDP was 10000 F which is equivalent to (at the above price) 5500 chickens. So, G-land was a larger economy and slightly richer than W-land in terms of per capita income since both had a population of three each.
Soon they met G-land people by visiting them in their own boat. G-land people also said that they did not want to trade with W-land, because they also had all that they needed. Econ said to himself that if both the countries have become self-sufficient and self-reliant, it was a great thing. So, there is no need to trade now. They stopped trading for a few years till Wonder Economist (Wecon) grew up a bit and started applying his mind.
Wecon talked to his parents as also the parents of his friend in G-land. Then, he did some calculations and produced a chart like this;
W-land maximum capacity to produce was either 10000 fruits, or 5000 chickens, besides 2000 fish in off season spare time., while G-land capacity was to produce 10000 fruits or 6000 chickens. Thus, G-land was more productive than W-land in respect of chickens they were equally productive in fruits. He shared this information with everyone. His parents were a bit disappointed, while his friend's parents were very proud that they were more productive.
Then Wecon told them that this information suggeste that G-land should produce only chickens and W-land should produce only fruits. And that would benefit both the countries. Both sets of parents were perplexed demanded to know how this were possible. Wecon replied as follows. Let us assume that to start with both G-land and W-land produced only fruits. So, each would produce 10000 fruits each. Now, if W-land wants to produce, say 1000 chieckens, it would have to cut fruit production by 2000 (so that they can divert one-fifth of their time and energy from fruit plucking to chicken raising: 10,000 fruit = 5000 chicken or 2000 fruits = 1000 chickens). On the other hand, if G land wants to produce 1000 chickens, they have to divert only one-sixth of their time from plucking of fruits to raising chicken and therefore would have to cut fruit production by 1333 only. This means that in terms of number of fruits foregone/ sacrificed, chicken in costilier in W-land than in G-land. It is in the interest of G-land, therefore to sell 1000 chickens to W-land and buy more than 1333 fruits, say 1500 fruits from W-land which W-land would be willing to do because if they were to produce 1000 chickens themselves they would have to reduce their fruit production by 2000. This means that G-land had a comparative advatage in chicken raising while W-and had comparative advantage in plucking fruits.
This appeared interesting. But the parents demande that Wecon illustrates how they would benefit. So, Wecon continued and said that let both countries to start with allocate half of their time and effort to both chicken and fruits. Then what would be the production scenario? W-land would produce 5,000 fruits and 2,500 chickens. G-land would produce 5000 fruits and 3000 chickens. Total apple production would be 10,000 and chicken production 5500. Now, let G-land produce only chicken and W-land only fruits. Total production would be 10,000 apples entirely by W-land and 6000 chickens entirely by G-land. Thus there is a net gain 500 chickens in total production and no loss in fruit production For both the countries. Now, W-land sells 5000 fruits to -land in exchange for 2750 chickens. So both of the countries are better off now: Both countries continue to have 5000 fruits each as before, but G-land has 3250 chickens instead of 3000 chickens and while W-land has 2750 chickens instead of 2500 chickens. So instead of producing both fruits and chickens they should specialise in the production of that in which each has comparative advantage.
Everyone understood how trading contributed to gains to both the countries. The international trade between the two countries resumed: annually, G-land sold 2750 chickens to and bought in return 5000 fruits (price of a fruit was thus equal to 0.55 chicken or price of a chicken is 1.8 fruits approximately).
Since G-land produced chickens only, their GDP was 6000 C (chicken as currency unit), or 10,800 F . W-land GDP was 10000 F which is equivalent to (at the above price) 5500 chickens. So, G-land was a larger economy and slightly richer than W-land in terms of per capita income since both had a population of three each.
03: International Trade
What did the Wonderland citizens do in the fourth year? An interesting event took place in the beginning of the year. One morning, Econ and Wonder while taking bath in the sea noticed a boat sailing at a distance and were thrilled. They waved their colored clothes to attract the attention of the people in the boat, hoping that they would rescue Econ family to their mainland home. Fortunately, the people in the boat noticed Econ and Wonder and turned their boat towards their island. Unfortunately, a man and a women came down from the boat after anchoring it near the beach and it turned out that this couple was in the same situation as Econ family: they had also lost themselves in the sea storm and currently living in another uninhabitated land a few nughtical miles away. Both families were please to meet each other and had lunch together. The visitors mentioned that they had named their island as Greatland and they were living on daily diet of only roasted chicken as there were planty of such birds available in that land. Since they had no fruit-bearing trees in Greatland, they could not eat fruits.
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
02: Growth
In the third year, Econ and Wonder did not spend time collecting fruit for the first 45 days. They survived by eating the Fruits in the stock and put their hard labor in building a thatched hut with three rooms: one for storing fruits and the other two for their living and working. They also made two thin but stout long wooden sticks and two ladders made from branches of trees that would enable them to collect more fruits. The stock of apples therefore got converted into physical assets: house, working place and a storage. All these are durable assets for productive use or consumption over longer periods than one year.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore, Savings S= F2500.
They converted all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So, Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, the third citizen was born: the baby was named Wonder Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With the availabilty of capital, productivity and production increased considerably.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore, Savings S= F2500.
They converted all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So, Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, the third citizen was born: the baby was named Wonder Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With the availabilty of capital, productivity and production increased considerably.
01: Income & Expenditure
Econ married Wonder and set of on sail for Honeymoon in the sea in their small boat. They wre unfortunate and faced a storm. The boat capsized and after hours of swimming they found themselves in an uninhabitated island. Since there was no way of going back home, they decided to settle down in the island that Econ named Wonderland after his beloved wife. There was nothing to eat on this island except fruits. They lived on fruits. Both of them plucked fruits. In the first year they plucked in all 4000 fruits. Econ told his wife that the Wonderland's economy had a National Income of F4000 where F stood for Wonderland Unit of measurement of Income. They of course needed no currency nor money because there was no exchange to be made among the citizens of Wonderland yet. But Econ calculated that he himself gathered 2000 fruits, Wonder 1500 and the remain 500 fruits came through joint efforts. So, Wonder said that his income was F2250 and Wonder's F1750. During the year, they consumed all the fruits they had gathered. So, their National expenditure worked out to F4000.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things would get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the third year later. Just now we note that GDP = National Income=Y=C+S=C+I=National Expenditure.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things would get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the third year later. Just now we note that GDP = National Income=Y=C+S=C+I=National Expenditure.
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