comparative advantageslide 1 the gains from trade why do people specialize in the production of a...

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Comparative advantage slide 1 The Gains from Trade The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people become self- sufficient instead, producing everything they need?

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Page 1: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 1

The Gains from TradeThe Gains from Trade

Why do people specialize in the production of a few goods or services and then trade?

Why don't people become self-sufficient instead, producing everything they need?

Page 2: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 2

An Example

Suppose there are two people, McPherson and Brown.

Both can produce Tacos and Spaghetti, but they are not equally adept.

Page 3: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 3

McPherson's Daily Production Possibilities

tacos

spaghetti10

5

Page 4: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 4

McPherson has preferences that make him want to consume 4 tacos and 2 spaghetti.

[Show his consumption point on the graph.]

Page 5: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 5

Brown's Daily Production Possibilities

tacos

spaghetti10

5

12

12

Brown

McPherson

Page 6: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 6

Suppose that Brown consumes 5 spaghetti and 7 tacos.

[Show his consumption point on the graph.]

Page 7: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 7

Without specialization and trade here's where they are in production and consumption:

S TBrown 5 7McPherson 2 4

Total 7 11

Page 8: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 8

Absolute advantage: A person has an absolute advantage in the production of a good if he/she uses less inputs to produce a unit of the good.

Notice that Brown has an "absolute advantage" in the production of both goods.

Page 9: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 9

Comparative advantage: A person has a comparative advantage in the production of a good if that person can produce an extra unit of the good at lower opportunity cost.

Page 10: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 10

Be sure you can answer these questions:

1) What's McPherson's cost of one more plate of spaghetti?

2) What's Brown's cost of one more plate of spaghetti?

3) Who has the "comparative advantage" in spaghetti production?

Go to hidden slide

Page 11: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 12

Now let McPherson specialize completely in the production of spaghetti, and Brown specialize completely in the production of tacos.

Page 12: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 13

The table shows total production with specialization. More is produced of both goods.

S TBrown 0 12McPherson 10 0

Total 10 12

Page 13: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 14

If Brown and McPherson can arrange to specialize and then trade, both can be better off.

In this case the gains from specialization are 3 plates of spaghetti and 1 taco.

Page 14: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 15

The Krugman Example

The Krugman example of comparative advantage starts with input requirements instead of output limits.

But the two are really equivalent.

Page 15: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 16

The table shows labor requirements per vehicle. What’s the MC of a bus?

200

300600

100

AUTO BUS

EAST

WEST

Page 16: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 18

Suppose each area had 3,000 hours total labor.

Then EAST could produce 30 AUTOS, or 15 BUSES. Or any combination in between.

And WEST could produce 5 AUTOS, or 10 BUSES. Or any combination in between.

Page 17: Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people

Comparative advantage slide 19

30

15

5

WEST

10

EAST

BUSES

AUTOS MC of a BUS in the East is 2.

MC of a BUS in the West is 0.5.