Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Comparative Advantage: The Basis for Trade

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Generalize or Specialize?  Generalize  People do all of their own tasks  People are“jack-of-all-trades”  People are self-sufficient Specialize  People do different tasks and trade to satisfy their wants  People are more productive  People produce greater output

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Comparative Advantage  A person has a comparative advantage in producing a particular good or service if  That person is relatively more efficient at producing it than producing other goods and services  Questions: What is the opportunity cost of producing?

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Absolute vs.Comparative Advantage  A person has an absolute advantage over another if  That person takes fewer hours to perform a task than the other person  A person has a comparative advantage over another if  That person’s opportunity costs of performing the task is lower than the other person’s opportunity cost

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Principle of Comparative Advantage  Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest  Output is increased when we all focus on those tasks in which we are relatively more productive; together we can produce vastly more than if we were all self-sufficient

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Sources of Comparative Advantage  Individuals  Possibly inborn talent  More often due to education, training, or experience  Countries  Difference in natural resources  Difference in cultures--incentives of institutions

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Production Possibilities Curve  A graph that describes the maximum amount of one good than can be produced for every possible level of production of the other good  For example, picking coffee beans or picking Macadamia nuts. The more time spent doing one, the less time there is available for the other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.1 Susan’s Production Possibilities

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Calculating Opportunity Cost  Susan’s opportunity cost of picking nuts:  OC nuts = loss in coffee/gain in nuts  Susan’s opportunity cost picking coffee beans:  OC coffee =loss in nuts/gain in coffee  The PPC shows the scarcity principle  more of one, means less of another

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Attainable and Unattainable  Attainable point  Any combination of goods that can be produced using currently available resources  Unattainable point  Any combination of goods that cannot be produced using currently available resources

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.1 Susan’s Production Possibilities

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Efficient and Inefficient  Efficient point  Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other  Inefficient point  Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.3 Tom’s Production Possibilities Curve

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Changes in PPC  Productivity  Increases in productivity shift the PPC out

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.4 Individual PPC’s Compared

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.5 PPC for a Two-Person Economy

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.6 Optimal Assignment of Production Tasks

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Principle of Increasing Opportunity Cost  AKA “The Low Hanging-Fruit Principle”  In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.7 An Especially Useful Division of Labor

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Gains from Specialization  Specialization produces gains for all, even when one person enjoys an absolute advantage in both tasks  Specialization  Uses differences in individual skills  Deepens skills via practice  Breaks tasks into simple steps multiplies the productivity of workers

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Gains from Specialization  This is the most important explanation of the difference in income levels across societies

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Even Specialization Has Costs  Most people enjoy variety in the work they do  Increased specialization means less variety  Overspecialization results in repetitive tasks

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.8 PPC for a Large Economy

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Smoothly Bowed PPC  Smooth because of a large population  Downward-sloping  Shows scarcity principle  Increasing Opportunity Cost  Greater production of one good results in rising opportunity cost of producing more of that good

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Comparative Advantage and International Trade  Each trading partner can benefit from trade, even if one partner is absolutely more productive  Without trade, the opportunity cost of producing is higher than it would be if trade occurrence, hence output is lower

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 3.9 PPC for a Small Island Nation

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig How Trade Expands the Menu of Opportunities

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig Gains from International Trade

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Volume of Trade  The volume of international trade has grown substantially over time  Most nations produce less than a small fraction of the total supply of any good or service, which allows these nations to benefit from the differences in domestic opportunity costs and global opportunity costs

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Why Trade Barriers?  If exchange is beneficial, why does anyone oppose it?  International trade does increase the total value of all goods and services, but certain industries may be harmed  E.G. Concerns over NAFTA  U.S. consumers would benefit from lower prices  But, some thought that the U.S. would lose some unskilled jobs to Mexico, which, however, has not been shown