Chapter 2 (Briefly)
The Principle of Comparative
Advantage
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Generalize or Specialize?
Generalize
People do all of their own tasks
People are “jack-of-all-trades”
People are self-sufficient
Specialize
People do different tasks and trade to
satisfy their wants
People are more productive/efficient
People produce greater output
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Comparative Advantage
A person has a comparative advantage
in producing a particular good or
service if
That person is relatively more efficient at
producing it than producing other goods
and services
Questions: What is the opportunity cost of
producing?
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Absolute vs. Comparative
Advantage
A person has an absolute advantage
over another if
That person takes fewer hours to perform
a task than the other person
A person has a comparative advantage
over another if
That person’s opportunity costs of
performing the task is lower than the other
person’s opportunity cost
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Principle of Comparative
Advantage
Everyone does best when each person
(or each country) concentrates on the
activities for which his or her
opportunity cost is lowest
Output is increased when we all focus
on those tasks in which we are
relatively more productive; together we
can produce vastly more than if we
were all self-sufficient
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Sources of Comparative
Advantage
Individuals
Possibly inborn talent
More often due to education, training, or
experience
Countries
Difference in natural resources
Difference in cultures--incentives of
institutions
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Efficient and Inefficient
Efficient point
Any combination of goods for which currently
available resources do not allow an increase in the
production of one good without a reduction in the
production of the other
Inefficient point
Any combination of goods for which currently
available resources enable an increase in the
production of one good without a reduction in the
production of the other
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Principle of Increasing
Opportunity Cost
AKA “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
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Gains from Specialization
Specialization produces gains for all,
even when one person enjoys an
absolute advantage in both tasks
Specialization
Uses differences in individual skills
Deepens skills via practice
Breaks tasks into simple steps multiplies
the productivity of workers
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Gains from Specialization
This is one of the most important
explanations of the difference in income
levels across societies
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Even Specialization Has Costs
Most people enjoy variety in the work
they do
Increased specialization means less variety
Overspecialization results in repetitive
tasks
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Comparative Advantage and
International Trade
Each trading partner can benefit from
trade, even if one partner is absolutely
more productive
Without trade, the opportunity cost of
producing is higher than it would be if
trade occurrence, hence output is lower
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Volume of Trade
The volume of international trade has
grown substantially over time
Most nations produce less than a small
fraction of the total supply of any good
or service, which allows these nations to
benefit from the differences in domestic
opportunity costs and global
opportunity costs
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Why Trade Barriers?
If exchange is beneficial, why does anyone
oppose it?
International trade does increase the total
value of all goods and services, but certain
industries may be harmed
E.G. Concerns over NAFTA (1994)
U.S. consumers would benefit from lower prices
But, some thought that the U.S. would lose some
unskilled jobs to Mexico, which, however, has not
been shown
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Naturalist Question
Why did Schuhmann decide to build
his own shed instead of hiring someone
to do it?
Notes:
Schuhmann is not even remotely close to
having any kind of comparative advantage in
building things, and he is well aware of this.
Schuhmann built the shed during the summer
(the whoooole summer) when he was not
teaching, but could have been consulting.
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Naturalist Question
Why do great chefs go out to eat?
Assume:
The great chef has the ability to cook all meals
for herself
The chef can sell the meals she cooks
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Comparative Advantage and
International Trade
Economic Naturalist
If trade between nations is so beneficial, why
are free-trade agreements so controversial?
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Exercise
Jane can produce 50 pizzas or 100 hamburgers per day, while Sam can
produce 30 pizzas or 90 hamburgers per day. Jane has an
A. absolute advantage in the production of pizzas, but not hamburgers,
and has a comparative advantage in the production of pizzas.
B. absolute advantage in the production of hamburgers, but not pizzas,
and has a comparative advantage in the production of hamburgers.
C. absolute advantage in the production of hamburgers, and pizzas, as
well as a comparative advantage in the production of hamburgers.
D. absolute advantage in the production of hamburgers, and pizzas, as
well as a comparative advantage in the production of pizzas.
E. absolute advantage in the production of hamburgers, and pizzas, as
well as a comparative advantage in the production of hamburgers and
pizzas.
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Example of Comparative Advantage and Mutual
Gains from Trade
Assume that Lara and Leah can spend the day either washing cars
or mowing lawns. The table below shows how much of each task
they could accomplish in one day if they spent the whole day
doing just that task. For example, Lara could wash 20 cars or
mow 5 lawns in one day.
______________________________________________
Lara
Leah
______________________________________________
Cars washed
20
15
Lawns mowed
5
3
______________________________________________
Question: Use the principle of comparative advantage to illustrate
how specialization can make them more productive than they
can be alone.
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CA and Trade cont’d…
Steps:
1. Calculate the opportunity cost of each activity for each person.
Lara
The opportunity cost of mowing 5 lawns is washing 20 cars.
 the opportunity cost of mowing 1 lawn is washing 4 cars.
 the opportunity cost of washing 1 car is mowing ¼ of a lawn.
Leah
The opportunity cost of mowing 3 lawns is washing 15 cars.
 the opportunity cost of mowing 1 lawn is washing 5 cars.
 the opportunity cost of washing 1 car is mowing 1/5 of a lawn.
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CA and Trade cont’d…
2. Use the opportunity costs to see who has comparative
advantage (lower opp cost) in each good, and
therefore who should specialize in each good.
Lara has a lower opportunity cost for mowing lawns so
she has the comparative advantage in lawns (she
gives up only 4 cars while Leah gives up 5 cars).
Leah has a lower opportunity cost for washing cars so
she has the comparative advantage in cars (she
gives up only 1/5 of a lawn while Lara gives up ¼
of a lawn).
 Lara should specialize in mowing lawns and Leah
should specialize in washing cars.
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CA and Trade cont’d…
Use the opportunity costs of each good to figure out
how much they would be willing to pay or accept in
a trade.
Since Lara is doing all the lawn mowing and Leah is
doing all the car washing, we can see that Lara will
trade some lawns for Leah’s car washing.
Questions:
a) how many lawns would Lara be willing to mow for
Leah if Leah washes one car for Lara?
b) how many lawns would Leah accept as a trade for
each car she washes for Lara?
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CA and Trade cont’d…
Answers:
a) Lara would mow up to ¼ of a lawn, but not more, for
each car that Leah washes for her (because this is
her opportunity cost or what she would have to give
up if she washed a car herself).
b) Leah would accept anything above 1/5 of a lawn, but
not less, for each car that she washes for Lara.
Notice that there is a “window” of opportunity for
trade. Any amount of lawns between ¼ and 1/5 will
be acceptable to both Lara and Leah and make them
both better off.
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Example of a mutually beneficial trade:
Suppose Lara mows 6 lawns for Leah.
What is the most that Leah would pay Lara (in car
washes) for these 6 lawns?
 Leah will pay up to 30 cars for this because for her
the opportunity cost of 1 lawn is 5 cars, so the
opportunity cost of 6 lawns is 30 cars.
What is the least that Lara will accept for these 6
lawns?
 Lara will accept anything greater than 24 cars for
this because for her the opportunity cost of 1 lawn is
4 cars, so the opportunity cost of 6 lawns is 24 cars.
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Example of a mutually beneficial trade:
If Leah gives Lara 27 cars for the 6 lawns (or any other
number between 24 and 30) then they will both be
better off.
Lara gets 27 cars washed at a “price” of only 6 lawns –
if she were to wash 27 cars herself she would have to
give up 6.75 lawns (27 x 0.25) – she is therefore better
off by ¾ of a Lawn.
Leah gets 6 lawns mowed at a “price” of only 27 cars –
if she were to mow 6 lawns herself she would have to
give up 30 cars (6 x 5) – she is therefore better off by
3 cars.
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Another one …
Suppose that Alex and Brandon are trapped on a desert island
where the only food available is fish and coconuts. Each of the
two individuals can spend their time catching fish or gathering
coconuts. The table below shows how much of each task they
could accomplish in one hour if they spent the whole hour doing
just that task. For example, Alex could catch 4 fish or collect 12
coconuts in one hour.
______________________________________________
Alex
Brandon
______________________________________________
Fish Caught
4
2
Coconuts collected
12
10
______________________________________________
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Fish and Coconuts …
Questions:
Who has the comparative advantage in
each good?
Illustrate a mutually beneficial trade
based on the principle of comparative
advantage.
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