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chap 2 - Chapter 2 Gains to Specialization and Exchange...

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8/28/2010 1 Chapter 2 Gains to Specialization and Exchange Learning objectives ` 1. Understand the nature of production efficiency based on comparative advantage ` 2 U i di id l d ti ibilit f ti t 2. Use individual production possibility frontiers to illustrate the concept of comparative advantage and resulting gains to specialization in production and exchange ` 3. Demonstrate how the resulting shape of the economy- wide production possibility curve illustrates the increasing marginal cost of production
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8/28/2010 2 Costs vary across individuals ` Example: ` Brain surgeon owns a Viper that needs repair ` Brain surgeon can fix car in 1 hour ` Mechanic needs 2 hours to fix car ` Who should fix the car? Two measures of ability ` Absolute advantage = ` 1) production of a good is achieved in less time or, equivalently, ` 2) more can be produced in the same amount of time ` Comparative advantage = cost of production is lowest
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8/28/2010 3 Determining comparative and absolute advantage ` Surgeon has absolute advantage in fixing the car because he can fix it faster ` If brain surgeon makes $1,000/hour and the mechanic charges $100/hour, the mechanic has comparative advantage in fixing the car ` Comparative advantage is the key to producing efficiently, at the lowest cost Two-person, two-task example ` 2 individuals own a cleaning business, Scott and Caroline ` 2 tasks ` Cleaning bathrooms ` Making beds # bathrooms/hr # beds/hr Scott 4 12 Caroline 3 10
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8/28/2010 4 Absolute Advantage ` Scott can clean more bathrooms in an hour ` Scott has absolute advantage in cleaning bathrooms ` Scott can make more beds in an hour ` Scott has absolute advantage in making beds Comparative advantage `
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