chap2 - Chapter 2 Comparative Advantage: The Basis for...

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Chapter 2 Comparative Advantage: The Basis for Exchange Why do markets exist? Why do trades (both domestic and international) happen?
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Many times, the choices we make involve trading or exchange goods and services: buy or sell Market economy, where (legal) exchange of goods and services are encouraged and facilitated by government, is the predominant form of economic system (planned economy is another) A major part of economics is to study how economic players make decisions in a marketplace (e.g., trades are involved) Why do people exchange goods and services in the first place?
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Q: Why not just grow our own food…
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Q: Why not just make our own clothes
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…paint our own houses… replace our own roofs…?
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Because we specialize (division of labor) and trade. Why specialize? We can all have more of every good and service if we specialize in the activities at which we are relatively most efficient. Division of labor trade is one engine for economic growth. Why do you have to choose you major? Because you want to specialize. Specialization is the foundation of modern economy
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Image: what would the life be like if you live on self-reliance where you have produce everything for yourself?
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The Principle of Comparative Advantage: Everyone does best when each person (or each country) concentrate on the activities for which his or her opportunity cost is lowest.
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Example of comparative advantage Time required by each to finish the each job Painting Roofing Bryan 2 days 1 day Paul 3 days 4 days
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Bryan has an absolute advantage over Paul at both painting and roofing, which means that Bryan takes fewer hours to perform each task than Paul. Painting Roofing Bryan 2 days 1 day Paul 3 days 4 days
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Bryan’s absolute advantage might seem to suggest that he does the roofing and painting jobs for both houses We assume that these two jobs are the only jobs they can choose Although Bryan has absolute advantage in both jobs, Paul actually has a comparative advantage over Bryan at painting, which means that he is relatively more efficient at painting than Bryan is.
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“To have a comparative advantage at a task” = “to have a lower opportunity cost of performing it” We often measure the OC of choice A in terms of choice B, i.e., by choosing A, we forego the chance to do B. OC of A in terms of B = Time to do A / Time to do B If task A takes 10 minutes and task B takes 5 minutes, the OC of A in term of B is 2: by choosing A, we forego the chance to do B twice. OC of B in terms of A= Time to do B / Time to do A The OC of B is: 5/10 =0.5 A: by choosing B, we forego the chance to finish job A by 50%.
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Paul has the comparative advantage in painting over Bryan and Bryan has the comparative advantage in roofing Painting Roofing Bryan 2 days 1 day Paul 3 days 4 days OC of painting OC of roofing Bryan 2 roofing jobs 0.5 painting job Paul 0.75 roofing job 1.33 painting job
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chap2 - Chapter 2 Comparative Advantage: The Basis for...

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