Notes on Comparative Advantage

Notes on Comparative Advantage - Notes on Comparative...

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Notes on Comparative Advantage 1 Notes on Comparative Advantage Kenny Christianson The Principle of Comparative Advantage: Each party to a trade should specialize in the production of that good in which it is relatively more efficient (or has a lower opportunity cost). Corollary: Mutual benefits arise from specialization and trade. The principle of comparative advantage is the economist’s main argument in favor of free trade. Absolute advantage: when one party has a lower resource cost than another. Comparative advantage: when one party has a lower opportunity cost than another. For example, Tiger Woods may have an absolute advantage in mowing the lawn, since he may be able to mow faster than anyone else. However, he does not have a comparative advantage in mowing the lawn, since his opportunity costs are too high. He is better off hiring someone else to mow his lawn, even if it takes that individual more time. Another example, Ed Johnson should not do his own typing, since that would take time away from running the television factory. EXAMPLE I: College Roommates (Absolute advantage). Suppose that during a two-day weekend, you and your roommate must do laundry and make popcorn. The amount that each of you can produce in a day is given by the table below: YOU ROOMMATE POPCORN / DAY 8 3 LAUNDRY / DAY 4 6 You have an absolute advantage in making popcorn; your roommate has an absolute advantage in doing laundry. First, determine opportunity costs. This is easiest by setting up ratios. YOU: ROOMMATE: 8P = 4L 3P = 6L *1P = ½L 1P = 2L 1L = 2P *1L = ½P Since you have a lower opportunity cost in popcorn (½L v 2L), you should specialize in popcorn production.
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Notes on Comparative Advantage 2 Since your roommate has a lower opportunity cost in laundry (½P v 2P), then she should specialize in laundry production. To show that more goods can be produced with specialization, first assume that we have a two- day weekend. We can compare the output without specialization to the output with specialization: TWO-DAY WEEKEND without specialization: with specialization: YOU – 1 day at each activity YOU – 2 days at popcorn ROOMMATE – 1 day at each
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This note was uploaded on 11/19/2010 for the course ECON 162 taught by Professor Christianson during the Spring '05 term at Binghamton.

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Notes on Comparative Advantage - Notes on Comparative...

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