Slide 3 - 0
Comparative Advantage:
The Basis for Trade
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 1
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
People produce greater output
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 2
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?
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 3
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 4
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 5
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 6
Production Possibilities Curve
A graph that describes the maximum
amount of one good than can be
produced for every possible level of
production of the other good
For example, picking coffee beans or
picking Macadamia nuts. The more time
spent doing one, the less time there is
available for the other
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 7
Fig. 3.1
Susan’s Production Possibilities
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 8
Calculating Opportunity Cost
Susan’s opportunity cost of picking
nuts:
OCnuts = loss in coffee/gain in nuts
Susan’s opportunity cost picking coffee
beans:
OCcoffee=loss in nuts/gain in coffee
The PPC shows the scarcity principle
more of one, means less of another
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 9
Attainable and Unattainable
Attainable point
Any combination of goods that can be
produced using currently available
resources
Unattainable point
Any combination of goods that cannot be
produced using currently available
resources
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 10
Fig. 3.1
Susan’s Production Possibilities
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 11
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 12
Fig. 3.3
Tom’s Production Possibilities Curve
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 13
Changes in PPC
Productivity
Increases in productivity shift the PPC out
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 14
Fig. 3.4
Individual PPC’s Compared
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 15
Fig. 3.5
PPC for a Two-Person Economy
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 16
Fig. 3.6
Optimal Assignment of Production Tasks
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 17
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 18
Fig. 3.7
An Especially Useful Division of Labor
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 19
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 20
Gains from Specialization
This is the most important explanation
of the difference in income levels across
societies
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 21
Even Specialization Has Costs
Most people enjoy variety in the work
they do
Increased specialization means less variety
Overspecialization results in repetitive
tasks
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 22
Fig. 3.8
PPC for a Large Economy
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 23
Smoothly Bowed PPC
Smooth because of a large population
Downward-sloping
Shows scarcity principle
Increasing Opportunity Cost
Greater production of one good results in
rising opportunity cost of producing more
of that good
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 24
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 25
Fig. 3.9
PPC for a Small Island Nation
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 26
Fig. 3.10
How Trade Expands the Menu of Opportunities
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 27
Fig. 3.11
Gains from International Trade
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 28
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Slide 3 - 29
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
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
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.