Comparative Advantage: The Basis for Exchange

1. Comparative Advantage: The Basis for Exchange

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

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

4. 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

5. 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 Opportunity Costsfor Paula and Beth • The Principle of Comparative Advantage • Should Paula update her own web page? Chapter 2: Comparative Advantage: The Basis for Exchange

6. 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

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

8. 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

9. Sources of Comparative Advantage • Individual • Inborn talent • Education • Training • Experience • Natural Endowments • Acquired Endowments • Superior Knowledge Chapter 2: Comparative Advantage: The Basis for Exchange

10. Exchange and Opportunity Cost • Question • Televisions and video cassette recorders were developed and first produced in the U.S. • Why did the U.S. fail to retain its lead in these markets? Chapter 2: Comparative Advantage: The Basis for Exchange

11. 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

12. Coffee (m lb/day) A 24 B 16 C 8 D Nuts m(lb/day) 0 4 8 12 Country A’s Production Possibilities Chapter 2: Comparative Advantage: The Basis for Exchange

13. A 12 B 8 C 4 D 8 16 24 Country B’s ProductionPossibilities Curve 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

14. A has an absolute and comparative advantage in gathering coffee 24 Country A’s PPC B has an absolute and comparative advantage in gathering nuts 12 Country B’s PPC 12 24 Individual Production Possibilities Curves Compared Coffee (‘000 lb/day) Nuts (lb/day) 0 Chapter 2: Comparative Advantage: The Basis for Exchange

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

16. 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

17. Comparative Advantage and Production Possibilities • The 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 afterward turn to resources with higher opportunity costs Chapter 2: Comparative Advantage: The Basis for Exchange

18. 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

19. 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

20. Factors That Shift The Economy’s Production Possibilities Curve • Why Have Countries Like Nepal Been So Slow to Specialize? • Low population density • Isolation • Factors that my limit specialization in other countries • Laws • Customs Chapter 2: Comparative Advantage: The Basis for Exchange

21. 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

22. 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