Presentation on theme: "THE CASE FOR TRADE: Comparative Advantage"— Presentation transcript:
1 THE CASE FOR TRADE: Comparative Advantage Trade (Interdependence)Instead ofProtectionism (Self-Sufficiency)
2 Adam Smith, Wealth of Nations, 1776 It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The taylor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a taylor.
3 David Ricardo, On the Principle of Political Economy and Taxation, 1817 Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats, he can only exceed his competitor by one-fifth or 20 percent, and in making shoes he can excel him by one-third or 33 percent;--will it not be for the interest of both that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats?
4 Basic Concept: One should do that which one does best One = a PersonOne = a BusinessOne = a RegionOne = a CityOne = a StateOne = a Nation
5 Absolute Advantage . . .Producing more outputs (goods and services) with a given number of inputs than anotherProducing an output with fewer inputs (resources—land, labor, capital, entrepreneurship) than another
6 Comparative Advantage . . . When one has the absolute advantage in producing both products, then each should produce that which they produce at the lowest opportunity cost!Both parties will benefit from specialization and trade.
7 Comparative Advantage Rule Specialization and trade are beneficial if there is a differenceIn opportunity costs.
8 CPA vs. Painter Makes $50/hr. Can paint house in 30 hrs. Makes $15/hr.
9 CPA vs. Painter Cost of hiring painter = 40 hours x $15/hr. = $600 Cost of CPA painting house = 30 hours x $50/hr. = $1500Although CPA can paint house better than painter, she should still hire painter
10 CPA vs. PainterCost of hiring CPA to do tax return = 2 hrs. x $50/hr. = $100Cost of Painter doing his own tax return = 10 hrs. x $15/hr. = $150CPA does BOTH better than painter – she should still hire painter to paint house while she does tax returns
11 Hatfields and McCoys 8 hrs./bushel of corn 10 hrs./yd. of cloth 18 hrs. for both16 hrs. for 2 bushels of corn15 hrs./bushel of corn12 hrs./yd. of cloth27 hrs. for both24 hrs. for 2 yds. of cloth
13 Hatfields and McCoys Yes, both families gain Absolute advantage in corn – HatfieldsAbsolute advantage in cloth – HatfieldsComparative advantage in corn – Hatfields (1 corn = .8 cloths)Comparative advantage in cloth – McCoys (1 cloth = .8 corns)
14 Comparative Advantage Problems Does the problem show increasing opportunity costs or constant costs?Is it an output problem or an input problem?What are the ratios?What are the terms of trade?
15 Why a nation trades and produces both products for domestic consumption . . . If there areincreasingopportunity costsInstead ofconstantThenAt some point the trade ratios of the two countries are equal, and there is no need to trade.
16 Inputs per output: Opportunity Cost Under — IOU Labor Hrs. per ComputerOppor. Cost of One ComputerLabor Hrs. per VCROppor. Cost of One VCRUSA3 hours1C : 3/2=1.5V2 hours1V : 2/3=.67CJapan1C : 3/1=3V1 hour1V : 1/3=.33C
17 Which country has the lowest opportunity cost for computers Which country has the lowest opportunity cost for computers? (USA--only 1.5 VCR’s per computer)Which country has the lowest opportunity cost for VCR’s? (Japan--only .33 of a computer per VCR)What should be the terms of trade? (1 computer for more than 1.5 VCR’s and less than 3 VCR’s
18 Outputs per input: Opportunity Cost Over--OOO Comp-tersOppor. Cost of One ComputerToma-toesOppor. Cost of One TomatoUSA501C=5000/50=100T50001T=50/5000=.01CMexico101C=4000/10=400T40001T=10/4000=.0025C
19 Which country has the lowest opportunity cost for computers Which country has the lowest opportunity cost for computers? (USA – only 100 units of tomatoes)Which country has the lowest opportunity cost for tomatoes? (Mexico—only of one computer)What should be the terms of trade? (1 computer for more than 100 tomatoes and less than 400 tomatoes)
20 Results of Specialization & Trade More efficient allocation of world resourcesMore goods and services (output) for all nationsMore world competition which deters monopolyMore domestic firms using lower cost production techniquesMore consumer choicesMore innovation in products and processesMore negotiating between nations
21 Causes of Economic Growth More and better resourcesNew technologyHigher productivityMore international trade?CapitaGoodsAndServiceslConsumerGoods & Services