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Comparative Advantage

Comparative Advantage. Chapter 2. Jack-of-all-trades, master of none…. Do we produce everything ourselves? Can you imagine a world where you had to produce virtually everything for yourself—food, clothes, lumber for to build your house, etc.?

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Comparative Advantage

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  1. Comparative Advantage Chapter 2

  2. Jack-of-all-trades, master of none… • Do we produce everything ourselves? • Can you imagine a world where you had to produce virtually everything for yourself—food, clothes, lumber for to build your house, etc.? • No, we specialize—we focus our attention on specific tasks, but which tasks?

  3. Absolute Advantage • If you take less time, money, or other opportunity cost measure, to perform a task than your neighbor, you have an absolute advantage over that person in that task.

  4. Absolute Advantage • Clearly, it costs less per unit to produce soybeans in country A and less per unit to produce textiles in country B. • OK, BUT, what if a country has an absolute advantage in the production of both goods. • China has lower labor costs across the board compared with the U.S., so why does China not produce everything?

  5. Comparative Advantage • We focus on those things where our opportunity costs are relatively smaller than our neighbor. They may have an absolute advantage, but everyone is better off if they specialize in their relative strength.

  6. Sources of Comparative Advantage • Natural Endowments • Land, Climate, etc. • Human society and culture • Important to remember that comparative advantage is not static; technology, government investment, changes in tastes and preferences; all change comparative advantage through time

  7. Production Possibilities • If we know your productivity in each task, we can construct a representation of the choices/combinations of production—production possibilities curve Note: The line represents the combinations that completely exhaust labor availability.

  8. Rudiments of Exchange • We can begin to understand economic exchange and opportunity cost through the PPC. • Based on the graph, the OC for one pound of nuts is 2 pounds of coffee, or, conversely, the opportunity cost of one pound of coffee is ½ pound of nuts. • The downward slope of the PPC reflects the Scarcity Principle—to get more of one good, we must give up some of the other

  9. Differing Productivity and the PPC • Different rates of productivity (i.e., different comparative advantage) can affect the shape of the PPC)

  10. Combinations • By combining producers and specializing, more of each good is produced and can be consumed 24 Specializing and trading yields more of both Coffee (lbs./day) 12 0 12 24 Nuts (lbs./day)

  11. PPC for a Many Person Economy

  12. Class Discussion • Causes and Consequences; Costs and Benefits of Outsourcing

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