Why Dont We Grow Bananas in Montana

1
Why Dont We Grow Bananas in Montana?
2
Situation

• Robert J. Moneymaker travels to Costa Rica,
• Observes the nutritious and tasty banana growing
  in Costa Rica,
• Believes that Montanans would also enjoy eating
  bananas.

3
Situation-Moneymakers Action

• Builds a 20 acre greenhouse 5 stories tall to
  produce bananas
• Sells 1 pound of bananas to each Montanan
• Charges 10 per lb. and the profit is 2 per lb.
  or 2 million per year
• Eventually Moneymaker lives in a million dollar
  house and drives a Mercedes

4
Situation-Middleman

• Later, Betty K. Middleman travels to Costa Rica
  and sees the abundance of bananas.
• Middleman notices Moneymakers lifestyle and
  figures he is making a lot of money.
• Recently developed shipping methods make the
  transport of bananas feasible.
• She ships bananas to Montana.
• She charges 2 per lb., to cover cost of 1 per
  lb and to make a profit of 1 per lb.

5
Situation-Moneymaker

• Moneymaker is livid
• Contacts politicians to prohibit or make the
  importation of bananas more expensive
• Moneymaker arguments are
• Investment risk in greenhouses.
• Costa Rica has unfair cost advantage particularly
  labor cost
• Provides jobs in Montana.
• Extra cost to the Montana consumer is small.
• Banana production in Montana results in consumer
  product and not just producing an input for out
  of state processors.
• Costa Rica bananas maybe a health risk.

6
Middleman Responds

• Only trying to serve the consumer with less
  expensive bananas
• Has no customer complaints
• Market should determine where bananas are produced

7
Consumer

• Consumer gain from trade is 8 per lb and the
  gain maybe greater than 8 million dollars since
  consumers are likely to expand consumption at the
  lower price.
• Each consumer gains a small amount so there is
  little incentive for the individual consumer to
  enter the debate.

8
Problem

• Appears to be a political and intellectual swamp
• Can economics help us better understand the
  problem and develop a rational solution?

9
Discussion Questions(Think like an economist)

• What are the policy alternatives?
• What should the policy makers do?
• Who gains and looses under the recommended
  policy?
• If your recommended policy adversely affects some
  parties, can that affect be ameliorated?

10
A Useful Tool Production Possibilities Frontier

• Resources are scarce.
• Resources or inputs could include land, labor,
  and/or capital.
• Inputs are used to produce outputs such as
  bananas and wheat.
• Since the inputs are scarce, the quantity of
  outputs are limited.

11
Production Possibilities Frontier(PPF)

• The PPF for bananas and wheat is graphed below
• PPF defines the combinations of outputs that can
  be produced if no inputs are wasted.

12
PPF Assumptions

• No waste
• Technology level
• Resource or input limit
• Production time

13
Slope of PPF

• PPF has a negative slope illustrating that one
  output can only increase if another output
  decreases. In the example, wheat can only
  increase if bananas decrease.
• The slope of the PPF is the amount of bananas
  that must be given up to increase wheat one unit.
• The slope is the opportunity cost of wheat in
  terms of bananas.

14
Linear PPF

• Assume a straight line PPF
• Algebraic B 20 4W
• Since the slope of the PPF is 4, the opportunity
  cost of wheat in terms of bananas is 4.

15
Concept Comparative Advantage

• PPFs vary by regions because of differences in
  resources and technology.
• Differences in technologies lead to comparative
  advantage.
• Exploited comparative advantage results in gains
  from trade.

16
PPF for Montana and Costa Rica

• Assume the two following simple linear PPFs for
  Montana and Costa Rica
• Bc 20 4 Wc Bm 10 - .2 Wm

?
?
Costa Rica PPF
?
?
? C
?
17
Opportunity Cost

• The slope of the PPF is the opportunity cost of
  producing wheat in terms of bananas.
• Opportunity cost of wheat in Montana is .2.
• Opportunity cost of wheat in Costa Rica is 4.
• The opportunity cost of wheat in Montana is lower
  than in Costa Rica so Montana has a comparative
  advantage in wheat.

18
Before Trade Quantities

• Before trade quantities are designated Points M,
  C, and N for Montana, Costa Rica, and combined.

19
After Trade Combined PPF

• Begin with 0 wheat and 30 bananas
• Increase wheat production (move to the right) by
  increasing Montana wheat and reducing Montana
  bananas
• Increase Montana wheat production (rather than
  Costa Rica wheat) because Montana has comparative
  advantage in wheat

20
After Trade Combined PPF

• Eventually cannot increase Montana wheat any more
  so then more wheat production must come from
  Costa Rica

?
?
Costa Rica PPF
?
?
?
C
?
21
After Trade Combined PPF

• The segment PQR dominates the before trade
  combination, Point N

22
After Trade Combined PPF

• Point P Same wheat, more bananas
• Point R Same bananas, more wheat
• Point Q More bananas, more wheat
• Superior combinations of bananas and wheat can be
  obtained from trade by exploiting comparative
  advantage
• Recall Montana has a comparative advantage in
  wheat and Costa Rica has a comparative
  disadvantage in wheat
• Comparative advantage was used to construct the
  after trade combined PPF since Montana wheat was
  chosen before Costa Rica wheat

23
Banana Comparative Advantage

• Reverse the variables in both the graphical and
  algebraic PPFs
  Wc 5 - .25 Bc
  Wm 50 5 Bm
• Costa Rica has a lower opportunity cost in
  bananas (.25 wheat) and therefore a comparative
  advantage in bananas.
• Montana has a higher opportunity cost in bananas
  (5 wheat) and therefore a comparative
  disadvantage in bananas.
• Therefore, Montana will avoid producing bananas
  and only produce bananas if a lot of bananas are
  wanted (more bananas than associated with Point
  Q).
• Costa Rica will emphasize banana production and
  produce all of the bananas if the number of
  bananas produced is less the amount associated
  with point Q.

24
Summary

• The amount of bananas and wheat chosen (point
  along the After Trade Combined PPF) will depend
  on
• Consumer preferences in Costa Rica and Montana.
• International marketing conditions in the
  multi-country situation.
• In most situations substantial gains from trade
  can be obtained by countries exploiting their
  comparative advantage

25
Discussion Questions

• What are the policy alternatives?
• What should the policy makers do?
• Who gains and who looses under your recommended
  policy?
• If your recommended policy adversely affects some
  parties, can that affect be ameliorated?
• Should adversely affected parties be compensated?
• Calculate the values associated with Points P,Q,
  and R in the previous table.

26
Discuss the Following Solution

• Policy makers allow the importing of bananas to
  obtain the gains from trade. Moneymaker is
  compensated for his greenhouses and workers are
  retrained for other equal paying jobs. The cost
  is borne by the government (taxes paid by
  consumers.)