Lecture 4 - Econ 201 Lecture 4 Comparative Advantage: The...

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Econ 201 Lecture 4 Comparative Advantage: The Basis of Exchange Why do people exchange goods and services in the first place? Why not just produce our own food, cars, clothing, shelter, and the like? The answer is that we can all have more of every good and service if we specialize in the activities at which we are we are relatively most efficient. Example 4.1 . Consider Ted, a house painter whose roof needs fixing and Tom, a roofer whose house needs painting. Although Ted is a painter, he also knows how to repair roofs. Tom, for his part, knows how to paint houses. The time each requires to perform these tasks is given in the table. How should the roofing and painting jobs be allocated among them? Painting Roofing Ted Tom 300 hours 400 hours 200 hours 100 hours Note in the table that Tom has an absolute advantage over Ted at both painting and roofing, which means that Tom takes fewer hours to perform each task than Ted does. At first glance, this might seem to suggest that Tom do the roofing and painting jobs for both houses. Of course, Tom would probably object to this proposal as being unfair. But an even more telling objection is that it is inefficient. The reason is that Ted has a comparative advantage over Tom at painting, which means that he is relatively more efficient at painting than Tom is. The word "relatively" is the key word here. For Ted to be relatively more efficient at a task is for him to have a lower opportunity cost of performing that task than Tom has. For Ted, the opportunity cost of painting one house = 0.75 roofing jobs For Tom, the opportunity cost of painting one house = 2 roofing jobs. Ted thus has a comparative advantage at painting, and it makes sense for him to do both painting jobs, leaving both roofing jobs for Tom. Note that if each person performed both tasks for himself, the total time spent would be 700 hours for Ted and 300 hours for Tom. By contrast, when each specializes in his comparative advantage, these totals fall to 600 for Ted and 200 for Tom, a savings of 100 hours each. The Principle of Comparative Advantage: Everyone does best when each person (or country) concentrates on the activities in which he or she is relatively most efficient. Specialization by comparative advantage provides the rationale for market exchange.
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Lecture 4 - Econ 201 Lecture 4 Comparative Advantage: The...

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