EQ: How do you compute comparative advantage and terms of trade? Agenda

1. Bellringer: Read about Tiger Woods’s dilemma written by N. Gregory Mankiw. Write the following question and answer on your bell ringer sheet below today’s date.

2. Should Tiger Woods mow his own lawn? Why or why not? Explain how people can benefit from specializing in certain tasks and trading. Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let’s imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does this mean he should? To answer this question, we can use the concepts of opportunity cost and comparative advantage. Let’s say that Woods can mow his lawn in 2 hours. In that same 2 hours, he could film a television commercial for Nike and earn $10,000. By contrast, Forrest Gump, the boy next door, can mow Woods’s law in 4 hours. In that same 4 hours, he could work at McDonald’s and earn $32. Who should mow Tiger’s grass?

3. In this example, Woods’s opportunity cost of mowing the lawn is $10,000 and Forrest’s opportunity cost is $32. Woods has an absolute advantage in mowing laws because he can do the work in less time. Yet Forrest has a comparative advantage in mowing lawns because he has the lower opportunity cost. • The gains from trade in this example are tremendous. Rather than mowing his own law, Woods should make the commercial and hire Forrest to mow the law.

4. EQ: How do you compute comparative advantage and terms of trade? • Agenda • Bellringer-Tiger Woods’s Dilemma • Lecture--Definitions • Burt and Betty Role Play • Lecture • Practice Problems

5. Comparative Advantage • Theory from David Ricardo • Explains the benefits of different individuals (or countries) specializing in a task (mowing laws, making commercials) and then trading.

6. Absolute vs. Comparative Advantage • Absolute advantage—the ability to produce more with the same amount of resources. • Comparative advantage—the ability to produce with the least amount of opportunity cost

7. Burt and Betty Role Play

8. Bert and Betty Role Play Questions • Who is better at cleaning the dishes? • Betty • If Bert and Betty work together, how many loads can they do in one hour? • 3 loads—Betty can do two by herself and Bert can do one. • How many minutes would it take for them to wash one load of dishes working together? • 20 minutes—one hour (60 minutes) divided by 3

9. Bert and Betty Role Play Questions • Who is better at sweeping up and taking out the trash? • Betty • If Bert and Betty work together, how many loads of trash can they do in one hour? • 4 loads—Betty can do three by herself and Bert can do one. • How many minutes would it take for them to sweep up and take out 3 loads working together • 45 minutes—one hour (60 minutes) divided by 4= 15 minutes x 3 loads=45

10. Option 1: Parents Plan to Work Together • Time to complete one sink full of dishes • 20 minutes • Time to complete three loads of trash • 45 minutes • Total time • 65 minutes

11. Option 2: Betty does the dishesand Bert cleans the garage • Time for one sink full of dishes • 30 minutes • Time to complete 3 loads of trash • 3 hours • Total • 3 hours

12. Option 3: Betty should do it all • Time to complete one sink full of dishes • 30 minutes • Time to complete 3 loads of trash • 1 hour • Total time=1 hour 30 minutes

13. Option 4: Specialization—Bert washes the dishes and Betty cleans the garage • Time to complete one sink full of dishes • 1 hour (by himself) • Time to complete 3 loads of trash • 1 hour (by herself) • Total time • 1 hour

14. Finding Comparative Advantage Output Problems • Output problems=number of goods/services produced • Input problems=amount of time or other resources used to produce

15. Finding Comparative Advantage Output Problems • Step 1: Set up the problem in a table. • Always set up the problems with the people (countries in the first column • Always doing it the same way=less confusion

16. Finding Comparative Advantage Output Problems Step 2: Find the opportunity cost for each person and task. For output problems ONLY—put the opposite number on top and reduce the fraction (if needed)

17. Finding Comparative Advantage Output Problems Step 3: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task. Who has the comparative advantage in dishwashing? • Look at the dishwashing column • See who has the lowest number as the opportunity cost.

18. Finding Comparative Advantage Output Problems Who has the comparative advantage in sweeping? • Look at the sweeping column • See who has the lowest number as the opportunity cost.

19. Another Example of Output • You may be given the entire production possibilities table. • Only look at the highest 2 numbers

20. Another Example of Output • Who has the absolute advantage in avocados? • The US--US can produce 90 and Mexico only 60. • Who has the absolute advantage in soybeans. • The US—US can produce 30 and Mexico only 15.

21. Alternative Presentation • Sometimes the problem uses the PPC instead of the table. • Again, look to the highest numbers for each country (person)

22. Set up the problem 90 30 60 15

23. Find the Comparative Advantage • Find the opportunity cost for each person and task. • Put the opposite number on top and reduce the fraction. • Opportunity cost to produce 1 avocado= • 30 soybeans/90 avocados= • 1 avocado=1/3 of a soybean 90 (1/3) 30 (3) 60 (1/4) 15 (4)

24. Find the Comparative Advantage Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task. Who has the comparative advantage in avocados? • Look at the avocado column • See who has the lowest number as the opportunity cost. 90 (1/3) 30 (3) 60 (1/4) 15 (4)

25. Find the Comparative Advantage Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task. Who has the comparative advantage in avocados? • Look at the avocado column • See who has the lowest number as the opportunity cost. • The Mexico has the comparative advantage 90 (1/3) 30 (3) 60 (1/4) 15 (4)

26. Find the Comparative Advantage Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task. Who has the comparative advantage in soybeans? • Look at the soybean column • See who has the lowest number as the opportunity cost. 90 (1/3) 30 (3) 60 (1/4) 15 (4)

27. Find the Comparative Advantage Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task. Who has the comparative advantage in soybeans? • Look at the soybean column • See who has the lowest number as the opportunity cost. 90 (1/3) 30 (3) 60 (1/4) 15 (4)

28. Importing and Exporting • US will make soybeans • Export soybeans • Import avocados • Mexico will make avocados • Export avocados • Import soybeans

29. Terms of Trade • Sometimes problems will ask about what terms of trade (price per good) would be beneficial to both nations. • For example—In order to be beneficial to both nations what should the terms of trade be for 1 avocado ? • The easiest thing to do is to look at the column for avocados and place the terms of trade as in between the two numbers. 1 avocado for more than ¼ of a soybean but less than 1/3 of a soybean. 90 (1/3) 30 (3) 60 (1/4) 15 (4)

30. Terms of Trade • What terms of trade would be beneficial to both nations for 1 soybean? • 1 soybean for 3.5 avocados • Must be more than 3 but less than 4. • Why? • It costs the US 3 avocados to make a soybean. So they must sell the soybean at a higher price than they’re cost. • BUT Mexico can make a soybean for 4 avocados. So in order to benefit, they must pay less than 4 avocados per soybean. • Who would benefit if the terms of trade were 1 soybean for 5 avocados? • US—because they are the sellers and they want at least 3 90 (1/3) 30 (3) 60 (1/4) 15 (4)

31. Absolute advantage in wheat? • Absolute advantage in TVs? • Comparative advantage in wheat? • Comparative advantage in TVs? • Who would benefit from 1 wheat for 2 tvs?

32. Absolute advantage in wheat? A • Absolute advantage in TVs? A • Comparative advantage in wheat? A • Comparative advantage in TVs? B • Who would benefit from 1 wheat for 2 tvs? A (1/2) (2) (1) (1)

33. Comparative Advantage—Input Problems • Not looking at how much the person (country) can produce, but how much resources it takes to produce the same good. • Absolute advantage • Who has the lower number? • Why? Because it takes him/her less resources. • Comparative advantage • Set up the same way • EXCEPT switch the order to find the opp. cost

34. Input ProblemsLiz and Joe at the Smoothie Bar • Joe can produce a salad OR a smoothie in only two minutes, but his new trainee Liz takes much longer to produce salads—10 minutes. However, she has worked on her smoothie skills and can turn one out in the same time as Joe. • Who has the absolute advantage in salads? • Joe • Who has the absolute advantage in smoothies? • Neither

35. Input Problems—Liz and Joe • Instead of putting the opposite number on top. Put the same on top. • Joe is the same 2/2. • But Liz--To find the opp. cost of producing 1 salad ask yourself, “How many smoothies could she produce in the time that it takes for her to produce 1 salad?” • 10/2=5 (1) (1) (5) (1/5)

36. Input—Cars and Computers in US and Japan • Assume that: the US can produce a car in 16 minutes; Japan can produce one in 14 minutes; the US can produce a computer in 12 minutes; Japan can produce one in 8 minutes. • Which country has the absolute advantage in producing cars? • Japan • Absolute advantage in producing computers? • Japan • Comparative advantage in producing cars? • Comparative advantage in producing computers? • Terms of trade advantageous to both?

37. Who is exporting cars? (4/7) 14/8= 7/4= ( 1 ¾ ) 16/12=4/3= ( 1 1/3) ( ¾ )

38. Winners and Losers of Free Trade

39. Winners and Losers of Free Trade • Who wins with free trade according to the theory of comparative advantage? • Everyone? • Consumers • Some Producers • Exceptions—dumping, currency manipulation • Who may lose with free trade? • Unskilled/ inadaptable labor • Society, if unable to deal with problems of poverty with unemployed unskilled labor