Comparative Advantage:
The Basis of Exchange
Chapter 2
1
The Basis of Exchange
 Why do people exchange goods and services in the first
place?
 Why is YAO Ming a top basketball player and Thomas
FRIEDMAN a prominent writer?
2
Why not do everything on our own?
 Should Joe Jamail write his own will?
 Jamail is the most renowned trial lawyer in American
History
 He is listed 195 on the Forbes list of the 400 richest
Americans, with net assets over $1 billion.
 Should Ms. Sarah Liao do her own household chores?
 Secretary for the Environment, Transport and Works
(SETW) of the Hong Kong Special Administrative
Region Government
 She knows how to do household chores.
3
Why not do everything on our own?
Grow our own food…
4
Why not do everything on our own?
replace our own roofs…?
…paint our own houses…
5
Why not do everything on our own?
We can all have more of every good and service if we
specialize in the activities at which we are relatively most
efficient.
6
Example 2.1. Basis for exchange
 Paul is a house painter whose roof needs replacing. Ron
is a roofer whose house needs painting.
 Although Paul is a painter, he also knows how to install
roofing. Ron, for his part, knows how to paint houses.
 Should Paul roof his own house? Should Ron paint his
own house?
Paul
Ron
7
Example 2.1. Basis for exchange
Time required by each to complete each type of job:
Painting
Roofing
Paul
300 hrs
400 hrs
Ron
200 hrs
100 hrs
Ron has an absolute advantage over Paul at both painting and
roofing, which means that Ron takes fewer hours to perform each
task than Paul does.
Should Ron do the roofing and painting jobs for both houses?
8
Example 2.1. Basis for exchange
Time required by each to complete each type of job:
Painting
Roofing
Paul
300 hrs
400 hrs
Ron
200 hrs
100 hrs
However, Paul has a comparative advantage over Ron at
painting, which means that he is relatively more efficient at
painting than Ron is.
9
Comparative advantage and opportunity cost
“To have a comparative advantage at a task”

(is the same as)
“To have a lower opportunity cost of performing it”
10
Example 2.1. Basis for exchange
Painting
Roofing
Paul
300 hrs
400 hrs
Ron
200 hrs
100 hrs
 For Paul, the opportunity cost of painting one house = the number
of roofing jobs he could do in the same time.
 Paul takes 300 hours to paint a house, 400 hours to roof a house.
 So in the time it takes Paul to paint a house, he could
complete .75 roofing jobs.
 So Paul’s opportunity cost of painting a house is .75 roofing jobs.
11
Example 2.1. Basis for exchange
Painting
Roofing
Paul
300 hrs
400 hrs
Ron
200 hrs
100 hrs
 For Ron, the opportunity cost of painting one house = the number
of roofing jobs he could do in the same time.
 Ron takes 200 hours to paint a house, 100 hours to roof a house.
 So in the time it takes Ron to paint a house, he could complete 2
roofing jobs.
 So Ron’s opportunity cost of painting a house is 2 roofing jobs.
12
Example 2.1. Basis for exchange
 Paul’s opportunity cost of painting a house is .75 roofing
jobs.
 Ron’s opportunity cost of painting a house is 2 roofing
jobs.
 Paul thus has a comparative advantage at painting,
because his opportunity cost of painting is lower than
Ron’s.
 Therefore it makes sense for Paul to do both painting
jobs and leave both roofing jobs for Ron.
13
Example 2.1. Basis for exchange
Painting
Roofing
Paul
300 hrs
400 hrs
Ron
200 hrs
100 hrs
 If each person performed both tasks for himself, the total time
spent would be 700 hours for Paul and 300 hours for Ron.
 By contrast, when each specializes in his comparative
advantage, these totals fall to 600 for Paul and 200 for Ron, a
savings of 100 hours each.
14
Principle of Comparative Advantage
 Everyone does best when each person (or country) concentrates
on the activities in which he or she is relatively most efficient.
 “Concentrates on the activities in which he or she is relatively most
efficient” means specialization.
 Specialization by comparative advantage provides the rationale for
market exchange.
 It explains why each person does not devote 10 percent of her
time to producing cars, 5 percent to growing food, 25 percent to
building housing, 0.0001 percent to brain surgery….
 By performing only those tasks at which we are relatively most
efficient, we can produce vastly more than if we each tried to be
self-sufficient.
15
Caution!!
 Pay close attention to the form in which the productivity
information is provided.
 Your goal in each case is to find each person’s
opportunity cost of producing the good in question.
16
Example 2.2.
Arthur can milk a goat in 10 minutes and shear a sheep in 4
minutes. Ben can milk a goat in 6 minutes and shear a
sheep in 3 minutes.
Which statement below is true?
a. Arthur has no comparative advantage.
b. Ben should do both tasks because he has an absolute advantage in
both.
c. Arthur has a comparative advantage in shearing sheep and Ben has
a comparative advantage in milking goats.
d. Arthur has a comparative advantage in milking goats and Ben has a
comparative advantage in shearing sheep.
e. None of the above statements is true.
17
Example 2.2.
Who has the comparative advantage of milking goats?
 Arthur can milk a goat in 10 minutes and shear a sheep in 4
minutes. Arthur’s opportunity cost of milking a goat is
 10/4 = 2.5 sheep shorn.
 Ben can milk a goat in 6 minutes and shear a sheep in 3 minutes.
Ben’s opportunity cost of milking a goat is
 6/3 = 2 sheep shorn.
 Who has a comparative advantage at milking goats?
 Ben, whose opportunity cost of milking a goat is lower.
18
Example 2.2.
Who has the comparative advantage of shearing sheep?
 Arthur can milk a goat in 10 minutes and shear a sheep in 4
minutes. Arthur’s opportunity cost of shearing a sheep is
 4/10 = 0.4 goats milked.
 Ben can milk a goat in 6 minutes and shear a sheep in 3 minutes.
Ben’s opportunity cost of shearing a sheep is
 3/6 = 0.5 goats milked.
 Who has a comparative advantage at shearing sheep?
 Arthur, whose opportunity cost of shearing a sheep is lower.
19
Example 2.2.
Arthur can milk a goat in 10 minutes and shear a sheep in 4
minutes. Ben can milk a goat in 6 minutes and shear a
sheep in 3 minutes.
Which statement below is true?
a. Arthur has no comparative advantage.
b. Ben should do both tasks because he has an absolute advantage in
both.
c. Arthur has a comparative advantage in shearing sheep and Ben has
a comparative advantage in milking goats.
d. Arthur has a comparative advantage in milking goats and Ben has a
comparative advantage in shearing sheep.
e. None of the above statements is true.
20
Example 2.3.
Arthur can milk 10 goats per hour or shear 4 sheep per hour.
Ben can milk 6 goats per hour or shear 3 sheep per hour.
Which statement below is true?
a. Arthur has no comparative advantage.
b. Ben should do both tasks because he has an absolute advantage in
both.
c. Arthur has a comparative advantage in shearing sheep and Ben has
a comparative advantage in milking goats.
d. Arthur has a comparative advantage in milking goats and Ben has a
comparative advantage in shearing sheep.
e. None of the above statements is true.
21
Example 2.3.
Who has the comparative advantage of milking goats?
 Arthur can milk 10 goats per hour or shear 4 sheep per hour. So his
opportunity cost of milking 1 goat is
 0.4 sheep shorn.
 Ben can milk 6 goats per hour or shear 3 sheep per hour. So his
opportunity cost of milking 1 goat is
 0.5 sheep shorn.
 Who has a comparative advantage at milking goats?
 Arthur, whose opportunity cost of milking a goat is lower.
22
Example 2.3.
Who has the comparative advantage of shearing sheep?
 Arthur can milk 10 goats per hour or shear 4 sheep per hour. So
his opportunity cost of shearing 1 sheep is
 2.5 goats milked.
 Ben can milk 6 goats per hour or shear 3 sheep per hour. So his
opportunity cost of shearing 1 sheep is
 2 goats milked.
 Who has a comparative advantage at shearing sheep?
 Ben, whose opportunity cost of shearing sheep is lower.
23
Example 2.3.
Arthur can milk 10 goats per hour or shear 4 sheep per hour.
Ben can milk 6 goats per hour or shear 3 sheep per hour.
Which statement below is true?
a. Arthur has no comparative advantage.
b. Ben should do both tasks because he has an absolute advantage in
both.
c. Arthur has a comparative advantage in shearing sheep and Ben has
a comparative advantage in milking goats.
d. Arthur has a comparative advantage in milking goats and Ben has a
comparative advantage in shearing sheep.
e. None of the above statements is true.
24
Sources of Comparative Advantage
 Individual
 Inborn talent
 Education
 Training
 Experience
 National Level
 Natural resources
 Cultural
 Institutions
 Non-economic
 Adoption of a language
 Institutions
What can we do to change our comparative advantage?
25
Economic Naturalist
 Televisions and videocassette recorders were developed
and first produced in the U.S.
 Why did the U.S. fail to retain its lead in these markets?
26
The Production Possibilities Curve
 A graph that describes the maximum amount of one
good that can be produced for every possible level of
production of the other good.
27
Example 2.4
 Chris can produce 6 sq yd/wk of shelter or 12 lb/wk of food.
 If Chris is the only person in the economy, describe the economy's
production possibilities curve.
Shelter (sq yd/wk)
6
4
2
0
12
4
8
Food (lb/wk)
28
Example 2.4
Production Possibilities Curve:
All combinations of shelter and
food that can be produced
with Chris’s labor.
Shelter (sq yd/wk)
6
4
2
0
12
4
8
Food (lb/wk)
The absolute value of the
slope of the production
possibility curve is 6/12 =
1/2.
For Chris, this means that
the opportunity cost of an
additional pound of food
each week is 1/2 sq yd/wk
of shelter.
29
Example 2.4
A, B, C, D
E
6
4
2
0
Unattainable
F
Shelter (sq yd/wk)
Attainable and efficient
Attainable but inefficient
A
F
C
E
D
B
12
4
8
Food (lb/wk)
30
Example 2.5
 Dana can produce 4 sq yd/wk of shelter and 4 lb/wk of food. If
Dana is the only one in the economy, describe the economy's
production possibilities curve.
Shelter (sq yd/wk)
Production Possibilities Curve:
All combinations of shelter and
food that can be produced
with Dana’s labor.
4
2
2
4
Food (lb/wk)
For Dana, the opportunity cost of an additional pound of food each
week is 1 sq yd/wk of shelter.
31
Production Possibilities in a Two-Person
Economy
 For Chris, the opportunity cost of an additional pound of food each
week is 1/2 sq yd/wk of shelter.
 For Dana, the opportunity cost of an additional pound of food each
week is 1 sq yd/wk of shelter.
 Thus, Chris has a comparative advantage in producing food,
because the opportunity cost of producing food is only half as large
as it is for Dana.
 By the same token, Dana has a comparative advantage producing
shelter.
32
Example 2.6
 Chris can produce 6 sq yd/wk of shelter or 12 lb/wk of food. Dana
can produce 4 sq yd/wk of shelter and 4 lb/wk of food. If Chris
and Dana are the only two people in the economy, describe the
economy's production possibilities curve.
Shelter (sq yd/wk)
Food (lb/wk)
33
Example 2.6
 Chris can produce 6 sq yd/wk of shelter or 12 lb/wk of food. Dana
can produce 4 sq yd/wk of shelter and 4 lb/wk of food. If Chris
and Dana are the only two people in the economy, describe the
economy's production possibilities curve.
Shelter (sq yd/wk)
Food (lb/wk)
34
Example 2.6
 Chris can produce 6 sq yd/wk of shelter or 12 lb/wk of food. Dana
can produce 4 sq yd/wk of shelter and 4 lb/wk of food. If Chris
and Dana are the only two people in the economy, describe the
economy's production possibilities curve.
Shelter (sq yd/wk)
Food (lb/wk)
35
Example 2.7
Dana and Chris, a married couple, have decided to consume, jointly,
6 sq yd/wk of shelter and 8 lb/wk of food. How should they divide
the task of producing these quantities?
Shelter (sq yd/wk)
Dana works full time making
shelter; Chris works 1/3 week
on shelter, 2/3 week on food.
10
6
4
8
12
16
Food (lb/wk)
36
Example 2.7
Shelter (sq yd/wk)
10
Dana works full time making shelter; Chris works
1/3 week on shelter, 2/3 week on food.
6
4
8
12 16
Food (lb/wk)
 Dana has a comparative advantage in producing shelter, but even if
she spends all her time producing shelter, she can make only 4 sq
yd/wk.
 So Chris will have to produce the additional 2 sq yd/wk for them to
achieve the desired 6 sq yd/wk.
 Since Chris is capable of producing 6 sq yd/wk of shelter on his
own, it will take him only 1/3 of a week to produce 2 sq yd.
 This leaves 2/3 of a week for him to produce food, which is exactly
how much time he needs to produce the desired 8 lb/wk.
37
The Principle of Increasing Opportunity Cost
(Also called “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.
38
Example 2.8
 Chris and Dana are now joined by George, whose
production-possibilities curve is shown below. What is
the production-possibilities curve for the new economy
consisting of Chris, Dana, and George?
Shelter (sq y ds/wk)
George' s production
possibility curve
2
1
Food
(lbs/wk)
39
Production Possibilities Curve with three persons
Shelter
(sq y d/wk)
12
Production P ossibilities Curve:
All com binations of shelter
and food that can be produced
with the labor of Chris, Dana
and George.
6
2
12
16 17
Food (lb/wk)
Opportunity cost of producing 1 pound per week of food
George's = 2 sq yds/wk of shelter.
Chris's = 1/2 sq yd/wk of shelter
Dana's = 1 sq yd/wk of shelter
40
Example 2.9
 If the economy consisting of Chris, Dana, and George is
to produce 14 lbs/wk of food and 4 sq yds/wk of shelter,
how should each person's work time be allocated?
Shelter
(sq yd/wk)
12
Chris: 0 sq yds/wk of shelter, 12 lbs/wk of food.
Dana: 2 sq yds/wk of shelter, 2 lbs/wk of food.
George: 2 sq yds/wk of shelter, 0 lbs/wk of food.
production point
6
4
2
12
Food (lb/wk)
14
16 17
41
The Production Possibilities Curve for an
Economy with Many Workers
Food (lbs/wk)
Clothing (garments/wk)
Produce the initial units of clothing using the resources that
are relatively most efficient at clothing production, and only
then turn to those that are relatively less efficient at clothing
production.
42
Economic Growth:
An Outward Shift in the Economy’s PPC
Factors Shifting the PPC
Coffee
(1000s of lb/day)
1. Increases in productive resources
(i.e. labor or capital)
New PPC
2. Improvements in knowledge and
technology
Original PPC
Nuts
(1000s of lb/day)
43
Factors That Shift The Economy’s Production
Possibilities Curve
 Increasing Productive Resources
 Investment in new factories and equipment
 Population growth
 Improvements in knowledge and technology
 Increasing education
 Gains from specialization
44
How much does specialization matter?
45
Example 2.10.
How much does specialization matter? (I)
 George and Tom are mechanics.
 Tom can replace 15 clutches per day or 10 sets of brakes, i.e., the
opportunity cost of replacing a pair of brakes is 1.5 clutches;
 George can replace 10 clutches per day or 15 sets of brakes, i.e.,
the opportunity cost of replacing a pair of brakes is 2/3 clutches.
 At their garage, the number of brake replacements performed each
day is the same as the number of clutch replacements.
 How much more can they accomplish if they specialize
than if each performed an equal number of brake and
clutch replacements?
46
Example 2.10.
How much does specialization matter? (I)
 If he doesn’t specialize, George can replace only 6
clutches per day and 6 sets of brakes.
Clutch replacements per day
10
George’s production
possibilities curve:
C = 10 - (2/3) B
George
6
0
6
Brake
15 replacements per
day
Want equal number of both
types of jobs: C = B
So write C = 10 – (2/3)C
and solve for C = 6.
47
Example 2.10.
How much does specialization matter? (I)
If Tom doesn’t
specialize, he too can
produce 6 jobs of
each type per day.
Clutch replacements per day
Tom’s production possibilities curve:
C = 15 - (3/2) B
Want equal number of both types of
jobs: C = B
So write C = 15 – (3/2)C and solve
for C = 6.
15
Tom
6
0
Brake
6 10 replacements per
day
48
Example 2.10.
How much does specialization matter? (I)
 By specializing, they can replace 15 clutches per day
(Tom) and 15 sets of brakes (George).
Clutch replacements/day
25
15
25
15
Brake replacements/day
49
Example 2.10.
How much does specialization matter? (I)
 So if neither George nor Tom specializes, the two can
produce a total of only 12 jobs of each type per day, .
 If they specialize, they can produce a total of 15 jobs
per day.
 A 25% increase in output isn’t bad,
 but cannot explain why industrialized countries
produce so much more than developing countries.
50
Example 2.11.
How much does specialization matter? (II)
 George and Tom are mechanics. Tom can replace 30 clutches per
day or 6 sets of brakes, i.e., the opportunity cost of replacing a pair
of brakes is 5 clutches.
 George can replace 6 clutches per day or 30 sets of brakes, i.e.,
the opportunity cost of replacing a pair of brakes is 0.2 clutches.
 At their garage, the number of brake replacements performed each
day is the same as the number of clutch replacements.
 Note that the difference in opportunity cost (5 vs. 0.2) is larger
than that in Example 2.10 (3/2 vs. 2/3).
 How much more can they accomplish if they specialize
than if each performed an equal number of brake and
clutch replacements?
51
Example 2.11.
How much does specialization matter? (II)
By specializing, they can
replace 30 clutches per
day (Tom) and 30 sets
of brakes (George)
Clutch
replacements per
day
36
30
0
30 36
Brake
replacements
per day
52
Example 2.11.
How much does specialization matter? (II)
If they don’t specialize,
each can replace only
5 clutches per day and
5 sets of brakes, for a
total of 10 daily
replacements of each
type.
Clutch
replacements
per day
30
Clutch
replacements per
day
6
5
0
Tom
George
5
5
30
Brake
replacements
per day
0
56
Brake
replacements
per day
53
Example 2.11.
How much does specialization matter? (II)
 By specializing, they can replace 30 clutches per day
(Tom) and 30 sets of brakes (George), i.e., 30 daily
replacement of each type.
 If they don’t specialize, each can replace only 5 clutches
per day and 5 sets of brakes, for a total of 10 daily
replacements of each type.
 The gain in output is three fold.
The gains from specialization are larger when differences
in opportunity cost are larger, and when individuals enjoy
comparative advantage in their respective specialties.
54
Gains from specialization will often be far more
spectacular!
 Division of labor according to talent and
temperament
 Learning by doing
 Specialized capital equipment
55
Adam Smith on specialization:
56
Adam Smith on specialization:
“One man draws out the wire, another straightens it, a third cuts it, a
fourth points it, a fifth grinds it at the top for receiving the head; to
make the head requires two or three distinct operations... I have
seen a small manufactory of this kind where only ten men were
employed... [who] could, when they exerted themselves, make
among them about twelve pounds of pins in a day. There are in a
pound upwards of four thousand pins of middling size. Those ten
persons, therefore, could make among them upwards of forty-eight
thousand pins in a day. Each person, therefore, making a tenth part
of forty-eight thousand pins, might be considered as making four
thousand eight hundred pins in a day. But if they had all wrought
separately and independently, and without any of them having been
educated to this peculiar business, they certainly could not each of
them have made twenty, perhaps not one pin in a day...”
57
Too much specialization?
 Specialization boosts
productivity, but it
also entails costs.
 Variety is one of the
first casualties.
58
Example 2.12.
Which job should Jane choose?
 Suppose Jane is a factory worker who must choose
between two jobs:
1. $1000/wk, little variety, or
2. $800/wk, high variety.
 If Jane values the additional variety offered by the
second job at $400 per week, which job should she
choose?
Although the first job pays $200 more than the second,
the second is actually worth more to Jane because its
additional variety is worth $400, or $200 more than
necessary to compensate for its lower salary. Therefore,
Jane should choose the second job.
59
Example 2.13. Why does excessive
specialization create profit opportunities?
 Suppose Jane is forced to move to the more specialized firm at a
salary of $1000 per week when her original employer dies.
 Explain how a new firm could lure her away from this job and
make additional profit for itself in the process.
 Her original employer was breaking even by paying Jane $800 per
week.
 She would be indifferent between working at the more specialized
job at a salary of $1000 and working at the less specialized job at a
salary of $600.
 So a new firm could offer her $700 per week for the less specialized
job.
 She would accept and the new firm would earn a profit of at least
$100 per week.
60
Example 2.13. Why does excessive
specialization create profit opportunities?
1. Because people are willing to pay for variety in their jobs, firms
that are willing to provide jobs with greater variety may be able to
earn additional profit.
2. The emergence of firms to offer jobs of variety benefits also the
workers.
3. Additional economic surplus is resulted.
61
Efficiency of specialization and variety
 A situation is efficient if it results in the largest
possible economic surplus.
 A situation is inefficient if it fails to achieve the largest
possible economic surplus.
 Specialization brings additional output.
 People like more output and also variety in their jobs.
 There is a trade-off between output and variety.
 Too much specialization could be inefficient.
62
The Efficiency Principle
Efficiency is a good thing, because when the
economic pie is larger, everyone can have a larger
slice.
63
Specialization vs. variety
 Why don’t people just choose the level of simplicity that seems to
work best for them?
 Possible answers:
Spending is tempting.
Hard to cut back when others don’t.
Bottom line: Life entails compromise. Specialization may be
unpleasant, but those who don’t specialize at all must accept low
wages or work extremely long hours.
We can expect to meet life’s financial obligations in the shortest time—
thereby freeing up more time to do whatever else we wish—if we
concentrate at least a significant proportion of our efforts on those
tasks for which we have a comparative advantage.
64
Comparative Advantage and International Trade
 The same logic that leads the individuals in an economy
to specialize and exchange goods with one another also
leads nations to specialize and trade among themselves.
 As with individuals, each trading partner can benefit
from exchange, even though one may be more
productive than the other in absolute terms.
65
Example 2.14. How does international trade
expand domestic consumption possibilities?
 Elizabeth and Dennis are the only two workers in
Islandia, a small island nation, and their production
possibilities curve is as shown.
Bananas
(lb/day)
120
100
E
100 120
In a closed economy,
consumption possibilities =
production possibilities
Tea
(lb/day)
66
Example 2.14. How does international trade
expand domestic consumption possibilities?
 In the world market, tea can be purchased or sold at a
price of $2 per pound and bananas can be bought or
sold at a price of $1 per pound.
 How does the opportunity to trade in the world markets
for bananas and tea affect consumption opportunities in
Islandia?
67
Example 2.14. How does international trade
expand domestic consumption possibilities?
 If Islandians specialized at the point E and sold all their
produce in the world market, they would earn
 $200 +$100 = $300 per day.
Bananas
(lb/day)
120
100
E
100 120
Tea
(lb/day)
68
Example 2.14. How does international trade
expand domestic consumption possibilities?
They could buy as
many 300 pounds of
bananas per day (point
F) or as many as 150
pounds per day of tea
(point G). Islandia
could also consume any
combination of tea and
bananas on the line FG.
In a open economy,
consumption possibilities >
production possibilities
Bananas
(lb/day)
300 F 1x300 + 2x0 = 300
1x150 + 2x75 = 300
120
100
E
1x100 + 2x100 = 300
1x0 + 2x150 = 300
G
Tea
150
100
(lb/day
120
69
Example 2.15. How does international trade
expand domestic consumption possibilities?
 In the world market, tea can be purchased or sold at a
price of $20 per pound and bananas can be bought or
sold at a price of $10 per pound.
 How does the opportunity to trade in the world markets
for bananas and tea affect consumption opportunities in
Islandia?
70
Example 2.15. How does international trade
expand domestic consumption possibilities?
 If Islandians specialized at the point E and sold all their
produce in the world market, they would earn
 $2000 +$1000 = $3000 per day.
Bananas
(lb/day)
120
100
Although their income is
10 times as large as
before, so are the prices
of all goods.
E
The relative prices has
not changed.
100 120
Tea
(lb/day)
71
Example 2.15. How does international trade
expand domestic consumption possibilities?
The relative price has not
changed. So the menu of
consumption possibilities is
unchanged.
They could buy as many 300
pounds of bananas per day
(point F) or as many as 150
pounds per day of tea (point
G). Islandia could also
consume any combination of
tea and bananas on the line
FG.
Bananas
(lb/day)
300 F
120
100
E
G
Tea
150
100
(lb/day
120
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Example 2.16. How does international trade
expand domestic consumption possibilities?
 Same as the preceding example, except now the prices of
both tea and bananas are $2 per pound.
 If Islandians again specialized at the point E and sold all
their produce in the world market, they would earn $200
Bananas
+$200 = $400 per day.
(lb/day)
120
100
E
100 120
Tea
(lb/day)
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Example 2.16. How does international trade
expand domestic consumption possibilities?
 They could buy as many
200 pounds of bananas
per day (point F) or as
many as 200 pounds per
day of tea (point G).
 Islandia could also
consume any
combination of tea and
bananas on the line FG.
Bananas
(lb/day)
200 F
120
100
Relative price has changed. So,
is the consumption possibilities.
E
120
100
G
200
Tea
(lb/day)
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True or false:
 There is no way the United States can gain by trading
with a nation whose workers are less productive than
theirs, in absolute terms, for every production process.
False. Each country can gain by specializing in the
products for which it is relatively more efficient, then
exporting those products and importing the products for
which it is relatively less efficient.
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Factors That Shift The Economy’s Production
Possibilities Curve
 Why Have Countries Like Nepal Been So Slow to
Specialize?
 Low population density
 Isolation
 Factors that may limit specialization in other countries
 Laws
 Customs
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Economic Naturalist
 If trade between nations is so beneficial, why are freetrade agreements so controversial?
77
Alan Blinder
"... one true test of whether a person is an economist is
how devoutly he or she lives by the principle of
comparative advantage."
--- Central Banking in Theory and Practice (1998, p.1)
http://en.wikipedia.org/wiki/Alan_Blinder
78
End
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