1. Comparative advantage
Today: An introduction to the advantages of trade

2. Becky’s linear production possibilities curve

3. Becky’s linear production possibilities curve
What points are attainable?
What points are efficient?

4. Attainable and efficient points
Any point on the production possibility curve
These points are efficient, since additional production of one good necessarily means that another good has lower production
Attainable points
F/B define an attainable point to be “any combination of goods that can be produced using currently available resources” (p. 43)

5. Back to Becky Efficient points: w, x, y, z, v
Attainable points: t, w, x, y, z, v
Unattainable point: u

6. Next, let’s look at a two-person economy
Suppose that Barbara and Sherry have the Production Possibility Curves (PPCs) as shown

7. Next, let’s look at a two-person economy
Barbara can do one of the following:
Copy 50 tests if she does not type letters
Type 25 letters and copy no tests
Something in between

8. Next, let’s look at a two-person economy
Sherry can do one of the following:
Copy 25 tests and do nothing else
Type 50 letters and do nothing else
Something in between

9. Opportunity cost
How much of one activity needs to be given up in order to do one more of the other?
Example: Barbara could type one less letter in order to copy two more tests

10. Absolute advantage and comparative advantage
“One person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person” (F/B p. 36)
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” (F/B p. 37)

11. New example Productivity in pizza production
Productivity in salad production
Greg
20 pizzas cooked per hour
10 salads made per hour
David
16 pizzas cooked per hour
4 salads made per hour

12. Drop units to save space
Notice that Greg has absolute advantage in producing both pizzas and salads
Productivity in pizza production
Productivity in salad production
Greg
20 / hour
10 / hour
David
16 / hour
4 / hour
However, we will see that each person has a comparative advantage in producing one of the goods

13. Comparative advantage
Before we can determine comparative advantage, we must ask about each person “how much of ____ must I give up in order to produce an additional ____?”
In other words, we need to determine the opportunity cost of making one more pizza or one more salad for both Greg and David

14. Opportunity cost table
Opportunity cost of cooking a pizza
Opportunity cost of making a salad
Greg
½ salad
2 pizzas
David
¼ salad
4 pizzas
Note that the two numbers in each row are mathematical inverses of each other

15. Comparative advantage
Opportunity cost of cooking a pizza
Opportunity cost of making a salad
Greg
½ salad
2 pizzas
David
¼ salad
4 pizzas
To find comparative advantage for each person, find the lowest number in each column

16. Comparative advantage
Opportunity cost of cooking a pizza
Opportunity cost of making a salad
Greg
½ salad
2 pizzas
David
¼ salad
4 pizzas
David has comparative advantage in cooking pizzas
Greg has comparative advantage in making salads

17. Some things to note Absolute advantage
The same person could have absolute advantage in everything
Comparative advantage in a two-person, two-good economy
Each person will almost always have comparative advantage in exactly one of the two goods

18. From Greg and David to a big economy
To produce an efficient point in an economy, each good needs to be produced with lowest opportunity cost
All units in this graph in millions

19. From Greg and David to a big economy
Notice that opportunity cost of pizzas increases from A to C
Opportunity cost increases as more is produced
All units in this graph in millions

20. Changes in a production possibilities curve
Some factors that can shift a production possibilities curve
Change in population
War
Investment in buildings, machines, and other forms of capital
Research and development in technology

21. From comparative advantage to trade
Recall that Greg had comparative advantage at making salads, while David’s was making pizzas
Greg could make more salads than he wants to eat and trade them for pizzas from David
Both can be made better off with trade

22. International trade
In the real world, trade is more complex than simple two-good economies
When trade becomes more open between countries, there are typically millions of winners and often only thousands of losers
Prices go down for goods on average
The few displaced workers must find an alternate form of work, typically at a lower wage

23. International trade
We will examine more about international trade in the next lecture
For more on international trade, read Ch. 9
Think about how trade benefits your everyday life
Example: You could speculate about the price of gas if OPEC countries stopped producing oil