2–12–1 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 2 Comparative Advantage: the Basis for Trade

2–22–2 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 2: Comparative Advantage: the Basis for Trade Exchange and opportunity cost Production and consumption possibilities and the benefits of trade Sources of comparative advantage Why have some countries been slow to specialise?

2–32–3 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Absolute Advantage One person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person

2–42–4 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Comparative Advantage One person has a comparative advantage over another if his or her OPPORTUNITY COST of performing a task is lower than the other person’s opportunity cost

2–52–5 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Should Jeff Update His Own Web Page? Jeff has an absolute advantage in web pages and in bicycle repairs Time to update web page Time to complete bicycle repair Jeff20 min10 min Beth30 min

2–62–6 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Where is Jeff’s Comparative Advantage? In which activity does he have the lower opportunity cost? Opportunity Cost of updating a web page Opportunity Cost of a bicycle repair Jeff2 bicycle repairs0.5 web page updates Beth1 bicycle repair1 web page update

2–72–7 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Zero Specialisation The principle of comparative advantage ignored If they split their time evenly and produce 16 web pages Web pagesBicycle repairs Jeff1224 Beth412 TOTAL1636

2–82–8 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Specialisation and Exchange The principle of comparative advantage observed If they specialise in their comparative advantage and exchange Web pagesBicycle repairs Jeff048 Beth160 TOTAL1648

2–92–9 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Comparative Advantage and the Community A community does best when each person specialises in the activity in which he or she has the lowest opportunity cost (has a comparative advantage) and trades with others at home and abroad

2–10 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade and Production and Consumption Possibilities The Production Possibilities Curve (PPC) –A graph that describes the maximum amount of one good that can be produced for every possible level of production of another good.

2–11 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Production Possibilities for Coffee and Computers Using Two Workers – Carlos and Maria Carlos: 100 kilos coffee or 1 computer per week, so that 1 computer has an opportunity cost of 100 kilos coffee Maria: 100 kilos coffee or 2 computers per week, so that 1 computer has an opportunity cost of 50 kilos coffee Therefore Maria has comparative advantage in computers, and Carlos has comparative advantage in coffee

2–12 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Production Possibilities Over 50 Weeks Both harvest coffee only: kilos Both make computers only: 150 computers Carlos specialises in coffee while Maria specialises in computers: 5000 kilos and 100 computers These define 3 points on the PPC

2–13 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Two Workers Means there are Two Segments on the PPC As we shift Maria out of coffee into computers, we lose only 50 kilos coffee for every computer gained But when Maria is full-time on computers and we also shift Carlos out of coffee into computers, we lose 100 kilos for every computer gained

2–14 Production Possibilities

2–15 Three Workers Means Three Segments on the PPC

2–16 Many Workers Means a Smooth PPC

2–17 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Trade Extends Consumption Possibilities Beyond the PPC Without trade, consumption possibilities are confined to the PPC With trade, consumption possibilities extend beyond the PPC With trade, consumption possibilities depend on the terms of trade – the rate at which exports exchange for imports

2–18 Consumption Possibilities and the Terms of Trade

2–19 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Sources of National Comparative Advantage Climate and resource endowments Stock of knowledge and experience Cultural factors

2–20 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank When Can Specialisation be Excessive? When it leads to a fall in productivity through monotony Specialisation makes us vulnerable to a loss of markets or falling prices for the few products in which we specialise