2Opportunity Cost - Example What does it cost to go to University?Direct Costs:Tuition Fees + Living Expenses etcOpportunity Cost?Lost Earnings (for instance £15K a year for 3 years)
3Absolute and Comparative Advantage – Example 2 Countries: Portugal and England2 Products: Wine and ClothPortugal can produce 100 wine or 50 cloth (or a mixture)England can produce 20 wine or 40 cloth (or a mixture)
4Mixture (pre trade) Cloth Wine Portugal 25 50 England 20 10 Total 40 100
5Absolute Advantage 2 Questions: Which Country has absolute advantage in cloth production?Which Country has absolute advantage in wine production?Portugal: It can produce more of both
6Opportunity CostWhat is the opportunity cost of cloth production in both countries?Portugal = 2 units of WineEngland = ½ unit of WineWhat is the opportunity cost of wine production in both countries?Portugal = 1/2 unit of ClothEngland = 2 units of Cloth
7Portugal 50 or 100 2 wine England 40 or 20 ½ Wine Cloth Wine Opportunity Cost of producing 1 clothPortugal50 or1002 wineEngland40 or20½ Wine
8Comparative Advantage 1. Which country has comparative advantage in cloth production?England as its opportunity cost of cloth production is lower.2. Which country has comparative advantage in wine production?Portugal as its opportunity cost of wine production is lower.Optimal for each country to specialise and then tradewith each other.
10TradeIt pays to specialise because of trade. Assume some simple prices:For example: England requires at least 1/2 unit of wine for 1 unit of cloth.Portugal needs at least 1/2 unit of cloth for 1 unit of wine.If we take some middle price (1 units of cloth per unit of wine). Then both countries can be better off through specialisation and trade.
11Post Trade Portugal 20 80 England Total 40 100 Cloth Wine Assume Portugal trades 20 wine for 20 cloth. Both can consume a combination of cloth and wine that was not possible pre-trade
12Cloth Wine Portugal 10 80 England 20 Total 100 Pre Trade Comparison (If Portugal & England produced the same amount of wine as their post trade amount)ClothWinePortugal1080England20Total100
13Comparative Advantage (2) Specialisation in Labour An individual is the best lawyer and the best secretary in town.(i.e. has absolute advantage in being a Lawyer and a Secretary)What should they do?