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Comparative Advantage. By Charlton tsaI. Key Concepts. Production Possibility Curve (Frontier): a graph (usually a convex curve) that shows all the possible maximum (i.e., efficient) combinations of goods that could be produced with the available resources given existing technology; aka PPC
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Comparative Advantage By Charlton tsaI
Key Concepts • Production Possibility Curve (Frontier): a graph (usually a convex curve) that shows all the possible maximum (i.e., efficient) combinations of goods that could be produced with the available resources given existing technology; aka PPC • Absolute Advantage: a country’s ability to produce more of a good/service than another country • Comparative Advantage: A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost: i.e. it has to forego less of other goods in order to produce it • Gains from Trade: It is beneficial for countries to trade (vs. being self-sufficient). When each country produces goods it has a comparative advantage in (specialization) and trades them for other goods, everybody gets more of the goods they want
Production Possibilities Curve • This country can produce guns and/or butter • Point A is inefficient • Point X is not possible • Any point on the PPC is efficient
Comparative Advantage Mary has comparative advantage in grapes because her PPC curve has a steeper slope; she is giving up less nuts to produce grapes This is true for all of the graphs—absolute advantage does NOT mean comparative advantage
Figuring It Out • For the UK to produce 1 unit of textiles it has an opportunity cost of 4 books (4 books/1 textile). However for India to produce 1 unit of textiles it has an opportunity cost of 1.5 books (3 books/2 textiles) • Therefore India has a comparative advantage in producing clothing because it has a lower opportunity cost • The UK has a comparative advantage in producing books (1/4 UK vs. 2/3 India) • So China should produce clothing and trade with the UK for computers
The Other Way Around • For hours per good, take the reciprocal. UK’s opportunity cost for textile is 1/4 book, India’s opportunity cost for textile is 2/3 book. • UK has comparative advantage in textiles • India has comparative advantage in books (3/2 India vs. 4 UK) • UK should produce textiles and trade India for books • WHEN TRADING: A country will only trade if the cost of obtaining the good is less than its own opportunity cost
How does it relate? • Comparative advantage connects to: • Scarcity: the PPC is based on scarcity; due to a limited amount of time and resources, a country can only produce so much of a certain good. Therefore, comparative advantage should determine what goods a country decides to produce given its resources. • Government Taxation: governments try to prevent the negative effects of comparative advantage (i.e. outsourcing, trade deficit) by imposing tariffs and other trade barriers to increase the sale of domestic goods. It is actually more beneficial to trade.
Is this real life? • Outsourcing and bringing foreign jobs back to America is a big 2012 election topic. But are we taking the right approach? http://online.wsj.com/article/SB10001424052970204124204577154894270577660.html • The US should focus on manufacturing products it has a comparative advantage in, such as high-tech manufacturing , instead of competing for low-end jobs http://www.nytimes.com/2011/08/28/magazine/does-america-need-manufacturing.html?pagewanted=all
Let’s Practice! • Which farm has the comparative advantage in the production of Corn? a. Reff's farm has the comparative advantage in the production of corn because this farm can produce more corn b. Reff's farm has the comparative advantage in the production of corn because it has the lowest opportunity cost c. Bru's farm has the comparative advantage in the production of corn because it has the lowest opportunity cost d. neither farm has the comparative advantage in the production of corn Answer: B
Numbers represent hours/unit Which country has the comparative advantage in the production of wine? a. Portugal because it has the lowest opportunity cost b. Portugal because it can produce wine faster c. England because it has the lowest opportunity cost d. England because it uses fewer resources in the production of guns Answer: A
Determine which country should specialize in the production of guns and which should specialize in the production of butter and determine why a. Oodles should specialize in the production of butter because it can produce more butter and Nerc should specialize in the production of guns because it uses fewer resources b. Oodles should specialize in the production of buttter because it has the lowest opportunity cost and Nerc should specialize in guns because it has the lowest opportunity cost c. Oodles should specialize in guns because it has the lowest opportunity cost for guns and Nerc should specialize in butter because it has the lowest opportunity cost for butter d. Oodles should specialize in both guns and butter because it can produce more of each good Answer: C
Free Response Practice • 1999 q.2 http://apcentral.collegeboard.com/apc/members/repository/microeco_99.pdf • Answers • http://apcentral.collegeboard.com/apc/members/repository/sg_microeco_99.pdf
