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06 COMPARATIVE ADVANTAGE

06 COMPARATIVE ADVANTAGE - SECTION 6 COMPARATIVE ADVANTAGE...

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SECTION 6: COMPARATIVE ADVANTAGE
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THEORY OF COMPARATIVE ADVANTAGE Specialization and free trade benefit all trading parties Both trading partners can gain by specializing in what they do best and trading with each other
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ABSOLUTE ADVANTAGE By using a given amount of resources, a person or country can produce more of a given item than another person or country can produce
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COMPARATIVE ADVANTAGE A person or country can produce a good or service at a lower opportunity cost than another person or country
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EXAMPLE: Suppose the US and China both produce computers and clothes Suppose in the US, in one day, a worker can produce 40 computers or 80 suits Suppose in China, in one day, a worker can produce 10 computers or 40 suits
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A US worker has an absolute advantage over a Chinese worker when producing computers US = 40 computers per day China = 10 computers per day A US worker has an absolute advantage over a Chinese worker when producing clothes US = 80 suits per day China = 40 suits per day US is “better” than China at everything Is there any reason for these two to trade?
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OPPORTUNITY COST For simplicity, assume constant opportunity cost in each country Let variable Y = computers Let variable X = suits For the US, the opportunity cost of 40 computers is 80 suits The slope of the PPF = (-40/80) = -.0.5 That is, to get 1 additional suit, US must give up 0.5 units of computers; (i.e. ½ of a computer)
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For China, the opportunity cost of 10 computers is 40 suits The slope of the PPF = (-10/40) = -0.25 That is, to get 1 additional suit, China must give up 0.25 units of computers; (i.e. ¼ of a computer)
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COMPARATIVE ADVANTAGE Opportunity cost of 1 more suit US must give up ½ of a computer China must give up ¼ of a computer
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China has a comparative advantage in the production of suits because China has a lower opportunity cost than the US in the production of suits.
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