MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 1
LECTURE 5 (2005.9.27)
CLASS TODAY
P23-42
MB MC
Comparative Advantage,
The Basis for Exchange
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 3
Overview
This chapter introduces comparative
advantage and shows that having people
specialize in the production in which they are
relatively more efficient allows the
production of more of everything,It
introduces the production possibilities curve
and develops the production possibilities
model to show precisely how specialization
enhances the productive capacity of an
economy.
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 4
Comparative Advantage,The Basis for
Exchange
What do you think?
Do the Nepalese
perform their own
services because
they are poor or are
they poor because
they perform their
own services?
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 5
Exchange and Opportunity Cost
Should Johnnie Cochran write his own
will?
Cochran earns more than $1,000 per hour
The cost of having a will prepared is less
than $800
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 6
Exchange and Opportunity Cost
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
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
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 7
Exchange and Opportunity Cost
The Principle of Comparative Advantage
Should Paula update her own web page?
Time to update
web page
Time to complete
bicycle repair
Paula 20 minutes 10 minutes
Beth 30 minutes 30 minutes
Opportunity Cost of
updating a web page
Opportunity Cost of a
bicycle repair
Paula 2 bicycle repairs 0.5 web page updates
Beth 1 bicycle repair 1 web page update
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 8
Exchange and Opportunity Cost
Paula
Beth
Web Pages Bicycle Repairs
12
4
24
12
Total 16 36
If they split their time evenly and produce 16web page
If they specialized in their comparative advantage
Paula
Beth
Web Pages Bicycle Repairs
0
16
48
0
Total 16 48
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 9
Exchange and Opportunity Cost
Exercise 2.1 Should Barb update her own web page?
Productivity in
programming
Productivity in
bicycle repair
Pat 2 web page updates /hour 1 repair/hr
Barb 3 web page updates / hour 3 repairs/hr
OC of updating a web
page
OC of a bicycle repair
Pat 0.5 bicycle
repairs
2 web page
updates
Barb 1 bicycle repair 1 web page
update
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 10
Exchange and Opportunity Cost
The 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
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 11
Exchange and Opportunity Cost
Sources of Comparative Advantage
Individual -----micro level
Inborn talent
Education
Training
Experience
National Level -------macro level
Natural resources
Cultural institutions
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 12
Exchange and Opportunity Cost
Economic Naturalist
Televisions and videocassette recorders
were developed and first produced in the
United States,
Why did the United States fail to retain its
lead in these markets?
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 13
Comparative Advantage and Production
Possibilities
The Production Possibilities Curve
(PPC)
A graph that describes the maximum
amount of one good that can be produced
for every possible level of production of
another good.
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 14
Comparative Advantage and Production
Possibilities
The Production Possibilities Curve
Assume
A small economy that
o Produces only two goods - coffee and nuts
o Has only one worker who works 6 hrs/day
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 15
Susan’s Production Possibilities
0
Coffee
(lb/day)
Nuts
(lb/day)
Opportunity Cost (OC)
1,OC(nuts) = Loss in
coffee/gain in
nuts=2
2,OC(coffee) = Loss
in nuts/gain in
coffee=1/2
16
8
4 8
24
Production Possibilities Curve,All
combinations of coffee and nuts that
can be produced with Susan’s labor
A
B
C
D
12
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 16
Susan’s Production Possibilities
The scarcity principle:
Having more of one
good generally means
having less of another
good.
Coffee
(lb/day)
Nuts
(lb/day)
A
B
C
D
24
0
16
8
4 8 12
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 17
Attainable and Efficient Points on Susan’s
Production Possibilities
Nuts
(lb/day)
A
B
Combination F,
Unattainable
C
Combination E,
Inefficient
D
Combinations A,B,C,
and D,Efficient
Coffee
(lb/day)
24
0
16
8
4 8 12
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 18
Comparative Advantage and Production
Possibilities
The Production Possibilities Curve
Attainable Point
Any combination of goods that can be
produced using currently available resources
Unattainable Point
Any combination that cannot be produced using
currently available resources
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 19
Comparative Advantage and Production
Possibilities
The Production Possibilities Curve
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
Efficient____Pareto-efficient
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
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 20
Exercise
Exercise 2.2 (p42)
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 21
Example,Problem 2
Time to waxing a
car
Time to washing a
car
Ted 20 minutes/car 60 minutes/car
Tom 15 minutes/car 30 minutes/car
OC of waxing a car OC of washing a car
Ted 1/3 cars
washes
3 cars waxes
Tom? cars washes 2 cars waxes
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 22
Example,problems 3
Because they have the same OC of producing a gallon of
cider,they cannot gain from specialization and trade.
Productivity of
apple cider
Productivity of feta
cheese
Toby 5 gallons/h 2.5 ounces/h
Kyle 3 gallons/h 1.5 ounces/h
OC of producing
apple cider
OC of producing feta
cheese
Toby 2 ounces/h 0.5 gallons/h
Kyle 2 ounces/h 0.5 gallons/h
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 23
Homework
REVIEW,P33-42
RQ,1,4,5
PROBLEMS,4,5,6
PREVIEW,P43-52
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 24
Lecture 6 (2005.9.29)
Class today
Recap
Context,p43~52
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 25
Recap (p33~42)
Absolute advantage
Comparative Advantage
The Principle of Comparative Advantage
The Production Possibilities Curve
Attainable Point
Unattainable Point
Efficient Point
Inefficient Point
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 26
Attainable and Efficient Points on Susan’s
Production Possibilities
Nuts
(lb/day)
A
B
Unattainable
C
Inefficient
D
Efficient
Coffee
(lb/day)
24
0
16
8
4 8 12
PPC
Attainable
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 27
Tom’s Production Possibilities
0
Nuts
(lb/day)
EXAMPLE 2.4(P24)
Tom’s Production Possibilities Curve for a 6 hour day
Coffee
(lb/day)
4
8
8 16
A
B
C
D
12
Tom’s Production Possibilities Curve,All
combinations of coffee and nuts that can be
produced with Tom’s labor
24
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 28
Individual Production Possibilities Curves
Compared
Nuts
(lb/day)0
12
24
Tom’s Production
Possibilities Curve
Tom has an absolute and
comparative advantage in
picking nuts
24
12
Susan’s Production
Possibilities Curve
Susan has an absolute and comparative
advantage in picking coffeeCoffee(lb/day)
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 29
Production Without Specialization
Nuts
(lb/day)0
12
24
12 24
Susan’s Production
Possibilities Curve
Assume,Susan and Tom allocate their time so
each person’s output is half nuts and half coffee
Tom’s Output = 2 hrs picking nuts = 8 lbs
4 hrs picking coffee = 8 lbs
Susan’s Output = 2 hrs picking coffee = 8 lbs
4 hrs picking nuts = 8 lbs
Total Output = 16 lbs each
8
8
B Tom’s Production
Possibilities Curve
Coffee
(lb/day)
Example2.4
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 30
Production With Specialization
Nuts
(lb/day)0
12
24
12 24
Susan’s Production
Possibilities Curve
Tom’s comparative advantage is in nuts so
he specializes in nuts and produces 24 lbs
Susan’s comparative advantage is in coffee so
she specializes in coffee and produces 24 lbs
Susan gives Tom 12 lbs of
coffee for 12 lbs of nuts
E
Tom’s Production
Possibilities Curve
Coffee
(lb/day)
Example 2.5
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 31
EXERCISE 2.4
assume,Susan,5 lb coffee/hr 1lb nuts/hr
Tom,1 lb nuts/hr 5 lb coffee/hr
Without Specialization
Susan,1 hrs coffee = 5 lb 5 hr nuts = 5 lb
Tom,5 hr coffee = 5 lb 1 hrs nuts = 5 lb
Total,10 lb 10 lb
With Specialization
Susan,30 lb coffee 0 lb nuts
Tom,0 lb coffee 30 lb nuts
Total,30 lb 30 lb
Comparative Advantage and Production
Possibilities
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 32
EXERCISE 2.4
Conclusion:
Without Specialization
Total output,10 lb 10 lb
With Specialization
Total output,30 lb 30 lb
The gains from specialization grow larger as
the difference in opportunity cost increases
Comparative Advantage and Production
Possibilities
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 33
Production Possibilities Curve For a Large
Economy
Nuts
(1000s of lb/day)
Assume,An economy with millions of workers
produces only two goods,coffee and nuts
100
80
OC(nuts)=
loss in coffee/gain in nuts
Coffee
(1000s of lb/day)
E
A B
C
D
15
20
90
95
20 30 75
77
Figure 2.6
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 34
The Principle of Increasing Opportunity
Cost (“The Low-Hanging-Fruit Principle”)
In expanding the production of any good,
first employ those resources with the
lowest opportunity costs,and only
afterward turn to resources with higher
opportunity costs
Comparative Advantage and Production
Possibilities
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 35
Economic Growth(increasing production of all goods):
An Outward Shift in the Economy’s PPC
Coffee
(1000s of lb/day)
Nuts
(1000s of lb/day)
Original PPC
New PPC
Factors Shifting the PPC
1,Increases in productive resources
(i.e.,labor or capital)
2,Improvements in knowledge and
technology
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 36
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
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 37
Factors That Shift The Economy’s
Production Possibilities Curve
Why have countries Like Nepal been So
slow to specialize?
Low population density
Isolation
Some factors that may limit specialization
in other countries
Laws
Customs
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 38
Factors That Shift The Economy’s
Production Possibilities Curve
Can we have too
much specialization?
What do you think?
What are the costs of
specialization?
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 39
Comparative Advantage and International
Trade
Economic Naturalist (p51)
If trade between nations is so beneficial,
why are free-trade agreements so
controversial?
MB MC
End of
Chapter
MB MC
Chapter 2,Comparative Advantage,The Basis for Exchange Slide 41
Homework
Review,chapter 2
Review questions,2,3
Problems:9