Comparative Advantage: The Basis for Exchange

1. 2. Comparative Advantage: The Basis for Exchange

2. 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? • Confucius said:”………..

3. 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

4. The Concept of Opportunity Cost • Opportunity cost of any choice • What we forego when we make that choice • Most accurate and complete concept of cost • Direct money cost of a choice may only be a part of opportunity cost of that choice • Opportunity cost of a choice includes both explicit costs and implicit costs • Explicit cost—dollars actually paid out for a choice • Implicit cost—value of something sacrificed when no direct payment is made

5. Opportunity Cost and Society • All production carries an opportunity cost • To produce more of one thing • Must shift resources away from producing something else

6. 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

7. 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

8. eXchange How if both sides are equivalent in opportunity cost ?

9. Time to update web page Time to complete bicycle repair Paula 20 minutes 10 minutes Beth 30 minutes 30 minutes Supergirl Paula has Absolute Advantage in everything. • Should Paula update her own web page?

10. 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 The Principle of Comparative Advantage • Should Paula update her own web page? • Or do something else?

11. Assume: Fixed endowment • How many web pages and bicycle repairs can Paula and Beth produce a day if they both work eight-hour days?

12. Web Pages Bicycle Repairs Time to update web page Time to complete bicycle repair Paula 12 4 24 12 Beth Paula 20 minutes 10 minutes 16 36 Total Beth 30 minutes 30 minutes If they split their time evenly , and produce 16 web pages + 36 bicycle repairs 36 16

13. Web Pages Bicycle Repairs Paula 0 16 48 0 Beth 16 48 Total Specialization and Division of Labor If they specialized in their comparative advantage 48 16

14. Question • Should Barb update her own web page?

15. Exchange and Opportunity Cost • Everyone does best • when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest

16. Application Where have all the .400 hitters gone?

17. Sources of Comparative Advantage Individual • Inborn talent • Education • Training • Experience

18. Sources of Comparative Advantage • National Level • Natural resources • Cultural institutions

19. Question • Televisionsand videocassette recorders were developed and first produced in the United States. • Why did the United States fail to retain its lead in these markets?

20. 1927 Bell lab TV demo

21. Why Sony’s CLIE failed? We do one thing Right and very well!

22. Production Possibilities Frontiers (PPF) • Curve showing all combinations of two goods that can be produced with resources and technology available • Society’s choices are limited to points on or inside the PPF

23. Comparative Advantage and Production Possibilities • The Production Possibilities Curve • A graph that describes the maximum amount of one good that can be produced for every possible level of production of another good.

24. Comparative Advantage and Production Possibilities • The Production Possibilities Curve Assume • A small economy that • Produces only two goods - coffeeandnuts • Has only one worker who works 6 hrs/day

25. Opportunity Cost (OC) • 1. OC nuts = Loss in coffee/gain in nuts • 2. OC coffee = Loss in nuts/gain in coffee A 24 B 16 Production Possibilities Curve: All combinations of coffee and nuts that can be produced with labor C 8 D 4 8 12 Susan’s Production Possibilities Coffee (lb/day) Nuts (lb/day) 0

26. Coffee (lb/day) A 24 B 16 C 8 D Nuts (lb/day) 0 4 8 12 Susan’s Production Possibilities The scarcity principle:tradeoff Having more of one good generally means having less of another good.

27. Susan’sAttainable and Efficient Points on Production Possibilities Coffee (lb/day) A 24 Combination F: Unattainable B 16 Combination E: Inefficient C 8 Combinations A, B, C, and D: Efficient D Nuts (lb/day) 0 4 8 12

28. 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

29. 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

30. The Production Possibilities Curve • 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

31. Tom’s Production Possibilities Curve: All combinations of coffee and nuts that can be produced with Tom’s labor A 12 B 8 C 4 D 8 16 24 Tom’s Production Possibilities Tom’s Production Possibilities Curve for a 6 hour day Coffee (lb/day) Nuts (lb/day) 0 How Individual Productivity Affects the Slope and Position of the Production Possibilities Curve

32. Susan has an absolute and comparative advantage in picking coffee 24 Susan’s Production Possibilities Curve Tom has an absolute and comparative advantage in picking nuts 12 Tom’s Production Possibilities Curve 12 24 Individual Production Possibilities Curves Compared Coffee (lb/day) Nuts (lb/day) 0

33. Tom’s Output = 2 hrs picking nuts = 8 lbs 4 hrs picking coffee = 8 lbs Coffee (lb/day) 24 Susan’s Production Possibilities Curve Susan’s Output = 2 hrs picking coffee = 8 lbs 4 hrs picking nuts = 8 lbs Total Output = 16 lbs each 12 B Tom’s Production Possibilities Curve 8 Nuts (lb/day) 0 8 12 24 Assume: Susan and Tom allocate their time so each person’s output is half nuts and half coffee ProductionWithout Specialization

34. Tom’s comparative advantage is in nuts so he specializes in nuts and produces 24 lbs Coffee (lb/day) 24 Susan’s Production Possibilities Curve Susan gives Tom 12 lbs of coffee for 12 lbs of nuts E 12 Susan’s comparative advantage is in coffee so she specializes in coffee and produces 24 lbs Tom’s Production Possibilities Curve Nuts (lb/day) 0 12 24 ProductionWith Specialization

35. Gains from specialization • The gains from specialization grow larger as the difference in opportunity cost increases • For Example Susan: 5 lb coffee/hr 1lb nuts/hr Tom: 1 lb nuts/hr 5 lb coffee/hr

36. The gains from specialization grow larger as the difference in opportunity cost increases • Without Specialization Tom: 5 hrs coffee = 5 lb 1 hr nuts = 5 lb Susan: 1 hr coffee = 5 lb 5 hrs nuts = 5 lb Total: 10 lb 10 lb

37. The gains from specialization grow larger as the difference in opportunity cost increases • With Specialization Tom: 30 lb coffee 0 lb nuts Susan: 0 lb coffee 30 lb nuts Total: 30 lb 30 lb

38. A 100 B Why would the Production Possibilities Curve have an outward bow? C 95 90 D 20 E 15 20 30 75 80 77 Production PossibilitiesCurve For a Large Economy Assume: An economy that produces only two goods, coffee and nuts Coffee (1000s of lb/day) Nuts (1000s of lb/day)

39. A B C D E At point A, all resources Quantity are used for of All Moving from point "other goods." Other Goods A to point B requires shifting resources 1,000,000 out of other goods 950,000 F and into health care. 850,000 700,000 At point F, 500,000 all resources W are used for 400,000 health care. Number of 100,000 200,000 300,000 400,000 500,000 Lives Saved Figure : The Production Possibilities Frontier

40. Increasing Opportunity Cost • According to law of increasing opportunity cost (成本遞增法則) • Or called Law of Diminishing returns • The more of something we produce • The greater the opportunity cost of producing even more of it • This principle applies to all of society’s production choices

41. The Search for a Free Lunch • Productive Inefficiency • More of at least one good can be produced • Without pulling resources from the production of any other good • No industry, firm or economy is ever 100% productively efficient • However, cases of gross inefficiency are not as common as you might think

42. Comparative Advantage & Production Possibilities • 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 • Ricardo’s 地租論

43. Factors Shifting the PPC 1. Increases in productive resources (i.e., labor or capital) 2. Improvements in knowledge and technology New PPC Original PPC Economic Growth: An Outward Shift in the Economy’s PPC Coffee (1000s of lb/day) Nuts (1000s of lb/day)

44. Discovery of oil • Cost downward • Shift out of PPF

45. 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

46. Barrier to specialize • Why have countries Like Nepal been So slowto specialize? • Low population density • Isolation • Some factors that may limit specializa-tion • Laws • Customs

47. Discussion • Can we have too much specialization? • What do you think? • What are thecosts of specialization? • Taylorism & Fordism • All-clerk

48. International Trade • Question • If trade between nations is so beneficial, why are free-trade agreements so controversial? • WTO

49. The End