Comparative Advantage Chapter 2-2. Trade and Comparative Advantage  The production possibility curve is bowed because individuals specialize in the production.

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Presentation transcript:

Comparative Advantage Chapter 2-2

Trade and Comparative Advantage  The production possibility curve is bowed because individuals specialize in the production of goods for which they have a comparative advantage and trade with others.

Trade and Comparative Advantage  To produce on the production possibilities curve, individuals must produce those goods for which they have a comparative advantage.

Trade and Comparative Advantage  Adam Smith argued that humankind’s proclivity to trade leads to individuals using their comparative advantage.

Markets, Specialization, and Growth  The growth in per capita income in the past two millennia has been astonishing.  This owes largely to the introduction of markets and democracy.

Markets, Specialization, and Growth  Markets allow specialization, leading to trade and growth.

Markets, Specialization, and Growth  As people are allowed to compete and specialize, they get better at what they do, develop new technologies, and the market grows ever larger.

Growth in the Past Two Millennia $6,000 $5,000 $4,000 $3,000 $2,000 $1, Per capita income (in 1990 international dollars) McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

The Benefits of Trade  When people trade, both parties expect to benefit from the trade.  Otherwise, why would they have traded in the first place?

The Benefits of Trade  The argument for the benefits of trade underlies the general policy of laissez- faire. Laissez-faire – an economic policy of leaving coordination of individuals’ actions to the market.

Production Possibilities without Trade  Pakistan can produce 4,000 yards of textile per day or 1 ton of chocolate per day.  Belgium can produce 1,000 yards of textile a day or 4 tons of chocolate per day.

Production Possibilities without Trade  Pakistan has a comparative advantage in producing textiles.  Belgium has a comparative advantage in chocolate.

Production Possibilities without Trade Chocolate (in tons) Textiles (in thousands of yards) Belgium Pakistan McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Production Possibilities without Trade  Pakistan has chosen to produce 2,000 yards of textiles and 0.5 tons of chocolate.  Belgium has chosen to produce 500 yards of textile and 2 tons of chocolate.

Production Possibilities without Trade  Point A: The combination of textile and chocolate chosen by Pakistan.  Point B: The combination of textile and chocolate chosen by Belgium.  Point C: The joint combination without trade.

Production Possibilities without Trade

Chocolate (in tons) Textiles (in thousands of yards) Belgium Pakistan A B C McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Production Possibilities without Trade  The two extreme combinations are both countries producing only textile (point D) and both producing only chocolate (point E).  The combined production possibilities curve with no trade is drawn by connecting these two points.

Production Possibilities without Trade Chocolate (in tons) Textiles (in thousands of yards) Belgium Pakistan A B C D E Joint (no trade) McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Production Possibilities with Trade  Point F: This is where each nation is focusing on that activity for which it has a comparative advantage. Pakistan produces 4,000 yards of textile. Belgium produces 4 tons of chocolate.

Production Possibilities with Trade

Chocolate (in tons) Textiles (in thousands of yards) C D E Joint (no trade) Joint (with trade) Gains from trade F McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Production Possibilities with Trade  The combined PPC is bowed out because of Point F – comparative advantage and specialization.

U.S. Textile Production and Trade  Two hundred yeas ago, the U.S had a comparative advantage in textile production.  Now, countries with cheaper labor, such as Bangladesh have the comparative advantage in textile production.

U.S. Textile Production and Trade  The gains from trade show up as higher pay for workers in Bangladesh and lower- priced cloth for U.S. consumers.