Comparative advantage

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Comparative advantage

• Today An introduction to the advantages of trade

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Beckys linear production possibilities curve
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Beckys linear production possibilities curve

• What points are attainable?
• What points are efficient?

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Attainable and efficient points

• 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)

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Back to Becky

• Efficient points w, x, y, z, v
• Attainable points t, w, x, y, z, v
• Unattainable point u

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Next, lets look at a two-person economy

• Suppose that Barbara and Sherry have the
  Production Possibility Curves (PPCs) as shown

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Next, lets 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

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Next, lets 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

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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

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Absolute advantage and comparative advantage

• 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 (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
  persons opportunity cost (F/B p. 37)

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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
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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

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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

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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

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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

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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

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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

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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
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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
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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

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From comparative advantage to trade

• Recall that Greg had comparative advantage at
  making salads, while Davids 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

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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

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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