1. THE CASE FOR TRADE: Comparative Advantage
Trade (Interdependence)
Instead of
Protectionism (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 Person
One = a Business
One = a Region
One = a City
One = a State
One = a Nation

5. Absolute Advantage . . .
Producing more outputs (goods and services) with a given number of inputs than another
Producing 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 difference
In 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. = $1500
Although CPA can paint house better than painter, she should still hire painter

10. CPA vs. Painter
Cost of hiring CPA to do tax return = 2 hrs. x $50/hr. = $100
Cost of Painter doing his own tax return = 10 hrs. x $15/hr. = $150
CPA 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 both
16 hrs. for 2 bushels of corn
15 hrs./bushel of corn
12 hrs./yd. of cloth
27 hrs. for both
24 hrs. for 2 yds. of cloth

12. Comparative Advantage
Corn
Cloth
Hatfields – 1 corn = .8 cloths (8/10)
McCoys – 1 corn = 1.25 cloths (15/12)
Hatfields – 1 cloth = 1.25 corns (10/8)
McCoys – 1 cloth = .8 corns (12/15)

13. Hatfields and McCoys Yes, both families gain
Absolute advantage in corn – Hatfields
Absolute advantage in cloth – Hatfields
Comparative 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 are
increasing
opportunity costs
Instead of
constant
Then
At 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 Computer
Oppor. Cost of One Computer
Labor Hrs. per VCR
Oppor. Cost of One VCR
USA
3 hours
1C : 3/2=1.5V
2 hours
1V : 2/3=.67C
Japan
1C : 3/1=3V
1 hour
1V : 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-ters
Oppor. Cost of One Computer
Toma-
toes
Oppor. Cost of One Tomato
USA 50
1C=5000/50=100T
5000
1T=50/5000=.01C
Mexico 10
1C=4000/10=400T
4000
1T=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 resources
More goods and services (output) for all nations
More world competition which deters monopoly
More domestic firms using lower cost production techniques
More consumer choices
More innovation in products and processes
More negotiating between nations

21. Causes of Economic Growth
More and better resources
New technology
Higher productivity
More international trade?
Capita
Goods
And
Servicesl
Consumer
Goods & Services