Presentation on theme: "Babe Ruth – why he switched from pitching to hitting The story here is one of comparative advantage. 1."— Presentation transcript:
Babe Ruth – why he switched from pitching to hitting The story here is one of comparative advantage. 1
Let’s say that in a production setting during each hour that you can make either 2 cookies or 3 pretzels. Also say that during each hour I can make either 1 cookie or 2 pretzels. It is obvious that in an hour you are better at both cookie making and pretzel making. When someone can produce more of an item than another in the same amount of time that person is said to have an absolute advantage in producing the item. You have an absolute advantage in producing both cookies and pretzels. Earlier in his career Babe Ruth was an outstanding pitcher. Maybe the best in his day. He was also an excellent hitter. Maybe one of the best ever. So, Babe Ruth had an absolute advantage in both hitting and pitching during the time he played baseball. 2
Let’s focus on what happens if each of us makes cookies. When you make cookies you can not make pretzels, and the trade-off is you give up 3 pretzels when you make 2 cookies. Another way to say this is that each cookie you make means you give up the ability to make 1.5 pretzels. In this case we say the opportunity cost for you in making 1 cookie is 1.5 pretzels. Note for me the opportunity cost of 1 cookie is 2 pretzels. So, in cookie making you have a lower opportunity cost and thus it is said that you have a comparative advantage in cookie making. But, when the focus is on making pretzels, when you make pretzels you give up 2/3rds of a cookie for each pretzel made while I only give up 1/2 of a cookie for each pretzel made. So, I have a comparative advantage in making pretzels. 3
WOW, while you are absolutely better than me in both cookie and pretzel making, I have a comparative advantage in pretzels!!!! So, when you look back at the Babe Ruth story, we can now say Babe Ruth had a comparative advantage in hitting and thus it made sense for him to give up pitching. The team he would play for would be much better off with him as a hitter. In the cookie/pretzel example let’s say you and I can trade cookies and pretzels in the ratio 1 cookie = 1.75 pretzels (called the terms of trade). Since you have a comparative advantage in cookies you should make only cookies and then trade for pretzels if you want some. Here is why. If you want pretzels and you make them on your own you only get 1.5 pretzels per cookie you don’t make. But if you make cookies you get 1.75 pretzels for each cookie you trade. 4
5 Since I have a comparative advantage in pretzels I should only make pretzels and then trade for cookies if I want some. Here is why. If I want cookies and I make them on my own I only get.5 cookies per pretzel I don’t make. But if I make pretzels I get about.57 cookies for each pretzel I trade. So, if each of us specializes in the item in which we have a comparative advantage and trades for the other item (as long as the terms of trade are good) each of us will be better off. The team that Babe Ruth played for was better off with him hitting because he had a comparative advantage in hitting.