Comparative advantage

1. Comparative advantage Today: An introduction to the advantages of trade

2. Becky’s linear production possibilities curve

3. Becky’s linear production possibilities curve • What points are attainable? • What points are efficient?

4. Attainable and efficient points • Efficient points • Any point on the production possibility curve • These points are efficient, since additional production of one good necessarily means that another good has lower production • Attainable points • F/B define an attainable point to be “any combination of goods that can be produced using currently available resources” (p. 43)

5. Back to Becky • Efficient points: w, x, y, z, v • Attainable points: t, w, x, y, z, v • Unattainable point: u

6. Next, let’s look at a two-person economy • Suppose that Barbara and Sherry have the Production Possibility Curves (PPCs) as shown

7. Next, let’s look at a two-person economy • Barbara can do one of the following: • Copy 50 tests if she does not type letters • Type 25 letters and copy no tests • Something in between

8. Next, let’s look at a two-person economy • Sherry can do one of the following: • Copy 25 tests and do nothing else • Type 50 letters and do nothing else • Something in between

9. Opportunity cost • How much of one activity needs to be given up in order to do one more of the other? • Example: Barbara could type one less letter in order to copy two more tests

10. Absolute advantage and comparative advantage • 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” (F/B p. 36) • 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” (F/B p. 37)

11. New example

12. Notice that Greg has absolute advantage in producing both pizzas and salads However, we will see that each person has a comparative advantage in producing one of the goods Drop units to save space

13. Comparative advantage • Before we can determine comparative advantage, we must ask about each person “how much of ____ must I give up in order to produce an additional ____?” • In other words, we need to determine the opportunity cost of making one more pizza or one more salad for both Greg and David

14. Opportunity cost table • Note that the two numbers in each row are mathematical inverses of each other

15. Comparative advantage • To find comparative advantage for each person, find the lowest number in each column

16. Comparative advantage • David has comparative advantage in cooking pizzas • Greg has comparative advantage in making salads

17. Some things to note • Absolute advantage • The same person could have absolute advantage in everything • Comparative advantage in a two-person, two-good economy • Each person will almost always have comparative advantage in exactly one of the two goods

18. From Greg and David to a big economy • To produce an efficient point in an economy, each good needs to be produced with lowest opportunity cost All units in this graph in millions

19. From Greg and David to a big economy • Notice that opportunity cost of pizzas increases from A to C • Opportunity cost increases as more is produced All units in this graph in millions

20. Changes in a production possibilities curve • Some factors that can shift a production possibilities curve • Change in population • War • Investment in buildings, machines, and other forms of capital • Research and development in technology

21. From comparative advantage to trade • Recall that Greg had comparative advantage at making salads, while David’s was making pizzas • Greg could make more salads than he wants to eat and trade them for pizzas from David • Both can be made better off with trade

22. International trade • In the real world, trade is more complex than simple two-good economies • When trade becomes more open between countries, there are typically millions of winners and often only thousands of losers • Prices go down for goods on average • The few displaced workers must find an alternate form of work, typically at a lower wage

23. International trade • We will examine more about international trade in the next lecture • For more on international trade, read Ch. 9 • Think about how trade benefits your everyday life • Example: You could speculate about the price of gas if OPEC countries stopped producing oil