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Comparative Advantage: The Basis for Exchange

Comparative Advantage: The Basis for Exchange. Comparative Advantage: The Basis for Exchange. What Do You Think? Do the Nepalese perform their own services because they are poor or are they poor because they perform their own services?. Exchange and Opportunity Cost.

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Comparative Advantage: The Basis for Exchange

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  1. Comparative Advantage: The Basis for Exchange

  2. Comparative Advantage: The Basis for Exchange • What Do You Think? • Do the Nepalese perform their own services because they are poor or are they poor because they perform their own services? Chapter 2: Comparative Advantage: The Basis for Exchange

  3. Exchange and Opportunity Cost • Should Johnnie Cochran write his own will? • Cochran earns more than $1,000 per hour • The cost of having a will prepared is less than $800 Chapter 2: Comparative Advantage: The Basis for Exchange

  4. Exchange and Opportunity Cost • Absolute Advantage • One person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person Chapter 2: Comparative Advantage: The Basis for Exchange

  5. Exchange and Opportunity Cost • Comparative Advantage • One person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost Chapter 2: Comparative Advantage: The Basis for Exchange

  6. Time to update web page Time to complete bicycle repair Paula 20 minutes 10 minutes Beth 30 minutes 30 minutes Exchange and Opportunity Cost • The Principle of Comparative Advantage • Should Paula update her own web page? Chapter 2: Comparative Advantage: The Basis for Exchange

  7. Opportunity Cost of updating a web page Opportunity Cost of a bicycle repair Paula 2 bicycle repairs 0.5 web page updates Beth 1 bicycle repair 1 web page update Exchange and Opportunity Cost • The Principle of Comparative Advantage • Should Paula update her own web page? Chapter 2: Comparative Advantage: The Basis for Exchange

  8. Exchange and Opportunity Cost • The Principle of Comparative Advantage • Should Paula update her own web page? • How many web pages and bicycle repairs can Paula and Beth produce a day if they both work eight-hour days? Chapter 2: Comparative Advantage: The Basis for Exchange

  9. Web Pages Bicycle Repairs Paula 12 4 24 12 Beth 16 36 Total Exchange and Opportunity Cost • The Principle of Comparative Advantage If Paula splits her time evenly and both produce 16 web pages Chapter 2: Comparative Advantage: The Basis for Exchange

  10. Web Pages Bicycle Repairs Paula 0 16 48 0 Beth 16 48 Total Exchange and Opportunity Cost • The Principle of Comparative Advantage If they specialized in their comparative advantage Chapter 2: Comparative Advantage: The Basis for Exchange

  11. Exchange and Opportunity Cost • Principle: You can always produce an extra unit of one good at lower opportunity cost through comparative advantage. • That is why the book says (p. 35), that • “The total number of [both] bicycle repairs and web updates accomplished if Paula & Beth both spend part of their time at each activity will always be smaller than … if each specializes [according to] comparative advantage.” • But what about the total number of each? Chapter 2: Comparative Advantage: The Basis for Exchange

  12. Exchange and Opportunity Cost • Notice, what if they had to achieve more than 16 web updates per day? • Let’s say we need 20 webs a day, and Paula & Beth still have 8 hours a day. • Even if Beth works her full 8 hours on the web, she can only make 16 pages a day. • That would mean Paula would have to work part-time against her comparative-advantage! Chapter 2: Comparative Advantage: The Basis for Exchange

  13. Exchange and Opportunity Cost A qualification to Comparative Advantage: • If there is big enough demand for a good for which some producer(s) have comparativedisadvantage, but an absolute advantage(Paula’s web pages), • and that demand can’t be met solely by those producer(s) for whom the good is a comparative advantage, given their limited resources, Then – • The absolute advantage producer(s) of the good must work againstcomparative, and with their absolute advantage! Chapter 2: Comparative Advantage: The Basis for Exchange

  14. Exchange and Opportunity Cost • The Moral – Opportunity Costs (OC) are not constant: they can change and override comparative advantage based solely on labor productivity or some similar measure. Chapter 2: Comparative Advantage: The Basis for Exchange

  15. Opportunity Cost of updating a web page Opportunity Cost of a bicycle repair Paula 2 bicycle repairs 0.5 web page updates Beth 1 bicycle repair 1 web page update Exchange and Opportunity Cost • The OC of Paula producing another bike repair at some point might not be just “0.5 web page updates.” • If we need those pages badly enough, it could be: “you all die.” Chapter 2: Comparative Advantage: The Basis for Exchange

  16. Exchange and Opportunity Cost • The Principle of Comparative Advantage • Should Barb update her own web page? Chapter 2: Comparative Advantage: The Basis for Exchange

  17. Exchange and Opportunity Cost Chapter 2: Comparative Advantage: The Basis for Exchange

  18. Exchange and Opportunity Cost • The Principle of Comparative Advantage • Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest Chapter 2: Comparative Advantage: The Basis for Exchange

  19. Exchange and Opportunity Cost • Economic Naturalist • Where have all the .400 hitters gone? • Ted Williams (Red Sox), last man to hit over 400 in a season (.406, in 1941) Chapter 2: Comparative Advantage: The Basis for Exchange

  20. Exchange and Opportunity Cost • Sources of Comparative Advantage • Individual • Inborn talent • Education • Training • Experience Chapter 2: Comparative Advantage: The Basis for Exchange

  21. Exchange and Opportunity Cost • Sources of Comparative Advantage • National Level • Natural resources • Cultural institutions Chapter 2: Comparative Advantage: The Basis for Exchange

  22. Exchange and Opportunity Cost • Economic Naturalist • Televisions and videocassette recorders were developed and first produced in the United States. • Why did the United States fail to retain its lead in these markets? Chapter 2: Comparative Advantage: The Basis for Exchange

  23. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • A graph that describes the maximum amount of one good that can be produced for every possible level of production of another good. Chapter 2: Comparative Advantage: The Basis for Exchange

  24. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • Assume • A small economy that • Produces only two goods - coffee and nuts • Has only one worker who works 6 hrs/day Chapter 2: Comparative Advantage: The Basis for Exchange

  25. Opportunity Cost (OC) • OC nuts = Loss in coffee/gain in nuts = 2 • 2. OC coffee = Loss in nuts/gain in coffee = 1/2 A 24 B 16 Production Possibilities Curve: All combinations of coffee and nuts that can be produced with Susan’s labor C 8 D 4 8 12 Susan’s Production Possibilities Coffee (lb/day) Nuts (lb/day) 0 Chapter 2: Comparative Advantage: The Basis for Exchange

  26. Coffee (lb/day) A 24 B 16 C 8 D Nuts (lb/day) 0 4 8 12 Susan’s Production Possibilities The scarcity principle: Having more of one good generally means having less of another good. Chapter 2: Comparative Advantage: The Basis for Exchange

  27. Attainable and Efficient Points on Susan’s Production Possibilities Coffee (lb/day) A 24 Combination F: Unattainable B 16 Combination E: Inefficient C 8 Combinations A, B, C, and D: Efficient D Nuts (lb/day) 0 4 8 12 Chapter 2: Comparative Advantage: The Basis for Exchange

  28. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • Attainable Point • Any combination of goods that can be produced using currently available resources • Unattainable Point • Any combination that cannot be produced using currently available resources Chapter 2: Comparative Advantage: The Basis for Exchange

  29. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • Efficient Point • Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other Chapter 2: Comparative Advantage: The Basis for Exchange

  30. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • Inefficient Point • Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other Chapter 2: Comparative Advantage: The Basis for Exchange

  31. Tom’s Production Possibilities Curve: All combinations of coffee and nuts that can be produced with Tom’s labor A 12 B 8 C 4 D 8 16 24 Tom’s Production Possibilities Tom’s Production Possibilities Curve for a 6 hour day Coffee (lb/day) Nuts (lb/day) 0 How Individual Productivity Affects the Slope and Position of the Production Possibilities Curve Chapter 2: Comparative Advantage: The Basis for Exchange

  32. Susan has an absolute and comparative advantage in picking coffee 24 Susan’s Production Possibilities Curve Tom has an absolute and comparative advantage in picking nuts 12 Tom’s Production Possibilities Curve 12 24 Individual Production Possibilities Curves Compared Coffee (lb/day) Nuts (lb/day) 0 Chapter 2: Comparative Advantage: The Basis for Exchange

  33. Tom’s Output = 2 hrs picking nuts = 8 lbs 4 hrs picking coffee = 8 lbs Coffee (lb/day) 24 Susan’s Production Possibilities Curve Susan’s Output = 2 hrs picking coffee = 8 lbs 4 hrs picking nuts = 8 lbs Total Output = 16 lbs each 12 B Tom’s Production Possibilities Curve 8 Nuts (lb/day) 0 8 12 24 Assume: Susan and Tom allocate their time so each person’s output is half nuts and half coffee Production Without Specialization Chapter 2: Comparative Advantage: The Basis for Exchange

  34. Tom’s comparative advantage is in nuts so he specializes in nuts and produces 24 lbs Coffee (lb/day) 24 Susan’s Production Possibilities Curve Susan gives Tom 12 lbs of coffee for 12 lbs of nuts E 12 Susan’s comparative advantage is in coffee so she specializes in coffee and produces 24 lbs Tom’s Production Possibilities Curve Nuts (lb/day) 0 12 24 Production With Specialization Chapter 2: Comparative Advantage: The Basis for Exchange

  35. Comparative Advantageand Production Possibilities • The gains from specialization grow larger as the difference in opportunity cost increases • For Example Susan: 5 lb coffee/hr 1lb nuts/hr Tom: 1 lb nuts/hr 5 lb coffee/hr Chapter 2: Comparative Advantage: The Basis for Exchange

  36. Comparative Advantage and Production Possibilities • The gains from specialization grow larger as the difference in opportunity cost increases • Without Specialization Tom: 5 hrs coffee = 5 lb 1 hr nuts = 5 lb Susan: 1 hr coffee = 5 lb 5 hrs nuts = 5 lb Total: 10 lb 10 lb Chapter 2: Comparative Advantage: The Basis for Exchange

  37. Comparative Advantageand Production Possibilities • The gains from specialization grow larger as the difference in opportunity cost increases • With Specialization Tom: 30 lb coffee 0 lb nuts Susan: 0 lb coffee 30 lb nuts Total: 30 lb 30 lb Chapter 2: Comparative Advantage: The Basis for Exchange

  38. A 100 B Why would the Production Possibilities Curve have an outward bow? C 95 90 D 20 E 15 20 30 75 80 77 Production PossibilitiesCurve For a Large Economy Assume: An economy that produces only two goods, coffee and nuts Coffee (1000s of lb/day) Nuts (1000s of lb/day) Chapter 2: Comparative Advantage: The Basis for Exchange

  39. Comparative Advantage and Production Possibilities • Principle of Increasing Opportunity Cost (“The Low-Hanging-Fruit Principle”) • In expanding the production of any good, first employ those resources with the lowest opportunity costs, and only later turn to resources with higher opportunity costs. Chapter 2: Comparative Advantage: The Basis for Exchange

  40. Factors Shifting the PPC 1. Increases in productive resources (i.e., labor or capital) 2. Improvements in knowledge and technology New PPC Original PPC Economic Growth: An Outward Shift in the Economy’s PPC Coffee (1000s of lb/day) Nuts (1000s of lb/day) Chapter 2: Comparative Advantage: The Basis for Exchange

  41. Factors That Shift The Economy’s Production Possibilities Curve • Increasing Productive Resources • Investment in new factories and equipment • Population growth • Improvements in Knowledge and Technology • Increasing education • Gains from specialization Chapter 2: Comparative Advantage: The Basis for Exchange

  42. Factors That Shift The Economy’s Production Possibilities Curve • Why have countries Like Nepal been So slow to specialize? • Low population density • Isolation • Some factors that may limit specialization in other countries: • Laws • Customs Chapter 2: Comparative Advantage: The Basis for Exchange

  43. Factors That Shift The Economy’s Production Possibilities Curve • Can we have too much specialization? • What do you think? • What are the costs of specialization? Chapter 2: Comparative Advantage: The Basis for Exchange

  44. Comparative Advantage and International Trade • Economic Naturalist • If trade between nations is so beneficial, why are free-trade agreements so controversial? Chapter 2: Comparative Advantage: The Basis for Exchange

  45. End of Chapter

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