Comparative Advantage. Or why trade is good

Transcription

1 Comparative Advantage Or why trade is good

2 Absolute vs. Comparative Advantage Absolute - better in every possible way being considered Comparative - better at a single task or is the least worst at a certain task, taking opportunity cost into consideration

3 Comparative Advantage Cheat Sheet Input method to determine comparative advantage If problem sets up comparison based on amount of time, resources or any other inputs used, determine opportunity cost of X by dividing amount country uses to make X by amount country uses to make Y

4 Example # 1 USA produces a car in 16 minutes. Japan produces a car in 14 minutes. USA produces a computer in 12 minutes, Japan in 8 minutes. Opportunity cost of USA to produce cars is = 1 1/3 computers for every car made. Who should make cars? Computers?

5 Cars vs. Computers Opportunity cost for USA making cars is 1 ⅓ computers Opportunity cost for Japan making cars is 1 ¾ computers ( 14 8 = 1 ¾) USA should make cars Opportunity cost for USA making computers is = ¾ car Opportunity cost for Japan making computers is 8 14 = 4/7 car Japan should make computers

6 Example # 2 Output Method If problem sets up comparison based on amount produced, determine opportunity cost of X by dividing amount country produces of X into amount country produces of Y. USA produces 33 toy cars per hour, China 36. USA produces 44 dolls per hour, China 72. Who should produce toy cars, dolls?

7 Toy cars vs. Dolls Opportunity cost for China making toy cars is = 2 dolls Opportunity cost for USA making toy cars is = 1 ⅓ dolls USA should make toy cars Opportunity cost for China making dolls is = ½ toy car Opportunity cost for USA making dolls is = ¾ toy car China should make dolls

8 Assume both Italy and Greece only produce wine and olive oil. It Italy hold a comparative advantage in wine production, which of the following statements is NOT true? a) Italy must hold an absolute advantage in the production of wine. b) Greece holds a comparative advantage in the production of olive oil. c) Italy s opportunity cost of producing one additional unit of wine is lower than Greece s. d) Greece s opportunity cost of producing one additional unit of olive oil is lower than Italy s. e) If trade is open between them, these countries have an incentive to trade.

9 Correct answer is (a) Italy doesn t have to have an absolute advantage in order to have a comparative advantage. Remember Kim and Kanye it takes her longer to do everything. Italy only has to have less of a sacrifice when making wine than Greece.

10 Read more about comparative advantage See additional comparative advantage/trade problems - questions 1 through 6 at the end of chapter 38 on page 863 of the McConnell textbook.

11 Suppose that Sam can knit 5 sweaters or make 4 blankets in one week and Dave can make 10 sweaters or 6 blankets in one week. Which is true? a) Sam has an absolute advantage when making blankets. b) Sam has an absolute advantage when knitting sweaters. c) Sam has a comparative advantage in blanketmaking. d) Sam has a comparative advantage in sweaterknitting. e) Sam has neither a comparative advantage in making blankets or sweaters.

12 Correct answer is c) Sam has a comparative advantage in making blankets Sam OC blankets 5/4 (1 ¼), OC sweaters 4/5 Rob OC blankets 10/6 (1 2/3), OC sweaters 6/10 (3/5) 1 ¼ less than 1 2/3 for blankets. Also, Dave has comparative advantage for sweaters 3/5 less than 4/5

13 A has both absolute and comparative advantage in manufactured goods. A has an absolute advantage in manufactured goods but a comparative advantage in service goods. B has a comparative advantage in service goods but no absolute advantage in either good. A has a absolute advantage in service goods but a comparative advantage in manufactured goods. B has an absolute advantage in manufactured goods, but without more info, comparative advantage can t be determined.

14 Correct answer is b) A can make 100 manufactured goods to B s 75 for an absolute advantage However, A has 1/3 manufactured good given up to make service goods to B s ½ so has a a comparative advantage making service goods.

15 Trade and Specialization Expand Production Possibilities

16 Specialization People doing specialized tasks Limited by the extent of the market People and regions / countries tend to specialize in activities where they have a comparative advantage (lower opportunity cost) By specializing, more of each good is produced, rather than everyone spending equal time producing less

17 Gains from Trade (Exchange) Voluntary exchange is mutually beneficial Exchange / economic activity is a positive-sum game, not a zero-sum game at the time of the trade Gains from trade are mutual, but not necessarily equal Assumes reasonably good information regarding the trade by buyers & sellers (No fraud, misrepresentation, etc.) Ignores disruption problems e.g. people losing jobs due to items being made more cheaply overseas.

18 Kanye v. Kim Kanye is better at both mowing and cooking but should he do both? No. Whatever task he has the lower opportunity cost for, that is what he should do and then trade with Kim Kanye has an absolute advantage at cooking and mowing, but a comparative advantage for cooking. Kim s opportunity cost for mowing is less than Kanye s, so she should trade lawn mowing.