D S

Comparative Advantage:The Basis for Exchange

Comparative Advantage:The Basis for Exchange

2. 2.

CA 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:”………..

CA 3

Exchange and Opportunity Cost

Should Johnnie Cochran write his own will?Cochran earns more than $1,000 per hourThe cost of having a will prepared is less

than $800

CA 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

CA 5

Opportunity Cost and Society

All production carries an opportunity costTo produce more of one thingMust shift resources away from

producing something else

CA 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

CA 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

CA 8

eXchange

How if both sides are equivalent in opportunity cost ?

CA 9

Supergirl Paula has Absolute Advantage in everything.

Should Paula update her own web page?

Time to updateTime to updateweb pageweb page

Time to complete Time to complete bicycle repairbicycle repair

PaulaPaula 20 minutes20 minutes 10 minutes10 minutes

BethBeth 30 minutes30 minutes 30 minutes30 minutes

CA 10

The Principle of Comparative Advantage

Should Paula update her own web page?Or do something else?

Opportunity Cost of Opportunity Cost of updating a web pageupdating a web page

Opportunity Cost of a Opportunity Cost of a bicycle repairbicycle repair

PaulaPaula 2 bicycle repairs2 bicycle repairs 0.5 web page updates0.5 web page updates

BethBeth 1 bicycle repair1 bicycle repair 1 web page update1 web page update

CA 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?

CA 12

If they split their time evenly ,and produce 16 web pages

+ 36 bicycle repairs

PaulaPaula

BethBeth

Web PagesWeb Pages Bicycle RepairsBicycle Repairs

1212

442424

1212

TotalTotal 1616 3636

36361616

Time to updateTime to updateweb pageweb page

Time to complete Time to complete bicycle repairbicycle repair

PaulaPaula 20 minutes20 minutes 10 minutes10 minutes

BethBeth 30 minutes30 minutes 30 minutes30 minutes

CA 13

Specialization and Division of Labor

If they specialized in their comparative advantage

PaulaPaula

BethBeth

Web PagesWeb Pages Bicycle RepairsBicycle Repairs

00

16164848

00

TotalTotal 1616 4848

1616 4848

CA 14

Question

Should Barb update her own web page?

Productivity in Productivity in programmingprogramming

Productivity inProductivity in

bicycle repairbicycle repair

PatPat 2 web page 2 web page updates per hourupdates per hour

1 repair/hr1 repair/hr

BarbBarb 3 web page 3 web page updates per hourupdates per hour

3 repairs/hr3 repairs/hr

CA 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

CA 16

Application

Where have all the .400 hitters gone?

CA 17

Sources of Comparative Advantage

Individual Inborn talent Education Training Experience

CA 18

Sources of Comparative Advantage

National Level Natural resources Cultural institutions

CA 19

Question

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?

CA 20

1927 Bell lab TV demo

CA 21

Why Sony’s CLIE failed?

We do one thingRight and very well!

CA 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

CA 23

Comparative Advantage and Production Possibilities

The Production Possibilities CurveA graph that describes the maximum

amount of one good that can be produced for every possible level of production of another good.

CA 24

Comparative Advantage and Production Possibilities

The Production Possibilities CurveAssumeA small economy thatProduces only two goods

- coffee and nutsHas only one worker who

works 6 hrs/day

CA 25

Susan’s Production Possibilities

0

Coffee(lb/day)

Nuts(lb/day)

Opportunity Cost (OC)1. OC nuts = Loss in

coffee/gain in nuts

2. OC coffee = Loss in nuts/gain in coffee

16

8

4 8

24

Production Possibilities Curve: Allcombinations of coffee and nuts that

can be produced with labor

A

B

C

D

12

CA 26

Susan’s Production PossibilitiesThe scarcity principle: tradeoffHaving 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

CA 27

Susan’s Attainable and Efficient Points on 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

CA 28

The Production Possibilities CurveAttainable Point

Any combination of goods that can be produced using currently available resources

Unattainable PointAny combination that cannot be produced using

currently available resources

CA 29

The Production Possibilities CurveEfficient 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

CA 30

The Production Possibilities CurveInefficient 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

CA 31

Tom’s Production Possibilities

0

Nuts(lb/day)

How Individual Productivity Affects the Slope and Position of the Production Possibilities Curve

Tom’s Production Possibilities Curve for a 6 hour day

Coffee(lb/day)

4

8

8 16

A

B

C

D

12Tom’s Production Possibilities Curve: All combinations of coffee and nuts that can be produced with Tom’s labor

24

CA 32

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 coffee

Coffee(lb/day)

CA 33

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 lbs4 hrs picking nuts = 8 lbs

Total Output = 16 lbs each

8

8

BTom’s Production Possibilities Curve

Coffee(lb/day)

CA 34

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)

CA 35

The gains from specialization grow larger as the difference in opportunity cost increasesFor Example

Susan: 5 lb coffee/hr 1lb nuts/hr

Tom: 1 lb nuts/hr 5 lb coffee/hr

Gains from specialization

The gains from specialization grow larger as the difference in opportunity cost increases

Without SpecializationTom: 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

CA 37

The gains from specialization grow larger as the difference in opportunity cost increases

With SpecializationTom: 30 lb coffee 0 lb nuts

Susan: 0 lb coffee 30 lb nuts

Total: 30 lb 30 lb

CA 38

Production PossibilitiesCurve For a Large Economy

Nuts(1000s of lb/day)

Assume: An economy that produces only two goods, coffee and nuts

100

80

Why would the Production Possibilities Curve have

an outward bow?

Coffee(1000s of lb/day)

E

AB

C

D

1520

9095

20 30 75

77

CA 39

Lives SavedNumber of

Quantityof All

Other Goods

100,000 200,000 300,000 400,000 500,000

1,000,000950,000

850,000

700,000

500,000

400,000 W

Figure : The Production Possibilities Frontier

At point A,all resourcesare used for"other goods." Moving from point

A to point B requiresshifting resourcesout of other goodsand into health care.

At point F,all resourcesare used forhealth care.

BA

C

D

E

F

CA 40

Increasing Opportunity Cost

According to law of increasing opportunity cost (成本遞增法則 )

Or called Law of Diminishing returnsThe more of something we produceThe greater the opportunity cost of

producing even more of it This principle applies to all of society’s

production choices

CA 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

CA 42

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

Comparative Advantage & Production Possibilities

CA 43

Economic Growth: 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 PPC1. Increases in productive resources

(i.e., labor or capital)

2. Improvements in knowledge and technology

CA 44

Discovery of oil

Cost downward Shift out of

PPF

CA 45

Factors That Shift The Economy’s Production Possibilities Curve

Increasing Productive ResourcesInvestment in new factories and equipment Population growth

Improvements in Knowledge and TechnologyIncreasing educationGains from specialization

CA 46

Barrier to specialize

Why have countries Like Nepal been So slow to specialize?Low population densityIsolation

Some factors that may limit specializa-tion LawsCustoms

CA 47

Discussion

Can we have too much specialization?

What do you think?What are the costs of specialization? Taylorism & Fordism All-clerk

CA 48

International Trade Question

If trade between nations is so beneficial, why are free-trade agreements so controversial?

WTO

D S

The EndThe EndThe EndThe End