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Unformatted text preview: Comparative Advantage
The Basis For Exchange Chapter 2 Outline The Principle of Comparative Advantage The Production Possibilities Curve Trade The Value of Time Should Bill Gates pick up a $1 bill he finds on the street? Bill Gates has assets worth over $50 billion Every year he earns a salary of $616,667 and takes home a bonus ranging from $350,000 to $500,000 (both numbers are on the low end of most CEOs) Assuming he earns $1 million per year, that boils down to around $7 per minute worked or $2 per minute overall. So if he's on the job, his opportunity cost is slightly higher than $1 for the 10 seconds it would take to bend down to pick up the dollar bill. If he's off the job, his OC is $0.33 so he should take it! What if Shaq (earning $20 million per year) saw that dollar bill? Advantages Comparative Advantage Absolute Advantage Principle of Comparative Advantage If Paula and Beth have a bike repair company, which one of them should build bikes and which one of them should update the company web page?
Time to update web page Time to complete bicycle repair Paula Beth 20 minutes 30 minutes 10 minutes 30 minutes Comparative versus Absolute Paula can do either task in a shorter time than Beth (Absolute Advantage) But what happens when we examine their opportunity costs?
Opportunity Cost of updating a web page Opportunity Cost of a bicycle repair Paula Beth 2 bicycle repairs 1 bicycle repair 0.5 web page updates
1 web page update The Principle of Comparative Advantage Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest In the example, specializing in one particular service helps the pair reach the most efficient outcome. Sources of Comparative Advantage Individual Inborn talent Education Training Experience National Level Natural resources Cultural Institutions Noneconomic Adoption of a language Institutions Application Televisions and VCRs were developed and first produced in the US Why did the US fail to retain its lead in these markets? What does the US specialize in? Production Possibilities Curve A graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good. PPC's are simplified representations of economies. Initially we will assume that there are only 2 goods produced in an economy. Additionally, each economy will be made up of only one worker Recall the Scarcity Principle Having more of one thing Less of another So if we produce more beer, we have less pizza All the points along the PPC line are efficient points of production We cannot move to a point above the PPC line (unattainable point) We should not move to a point below the PPC (inefficient point) 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 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 PPF Comparisons Suppose that Canada also produces pizza and beer: Individual PPCs On One Graph Gains From Specialization The two nations can specialize in the good in which they hold the comparative advantage The gains from specialization grow larger as the difference in opportunity cost increases An examination of comparative advantages can illustrate the terms of a potential trade agreement Trade Larger Economy 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 So some people are simply better at one task than another task (comparative advantages) How Does Economic Growth Impact a PPC? What else can shift a PPC outward? Increasing Productive Resources Investment in new factories and equipment Population growth Improvements in general knowledge and technology Increasing education Gains from specialization What about specific technologies? Example: An automated pizza dough stretcher that doubles pizza production per hour Final Thoughts Can we have too much specialization? What do you think? What are the costs of specialization? If trade between nations is so beneficial, why are free-trade agreements so controversial? ...
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- Fall '08
- Comparative Advantage