Module 4 Comparative Advantage &

Trade1

What you will learn in this Module• How trade leads to gains

for an individual or an economy

• The difference between absolute advantage and comparative advantage

• How comparative advantage leads to gains from trade in the global marketplace

We Gain from Trade. No Question About It!

• Can you make everything you need to sustain your lifestyle?

• NOOOOOOOOOOOO!!• People are better off from trade ~ or providing

goods and services to others & receiving goods and services in return

• You get more that way than if you tried to be self sufficient and do it all yourself

• WHY? A word called specialization….

An economy can produce more as a whole when each person specializes and in a task and trades with others for what she is not good at producing….

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We Gain from Trade. No Question About It!Activity

1. Get with your Econ Buddy. Talk to each other and figure out 3 things each of you do better than the other. Choose one each that would mutually benefit you both. Assign a value to whatever it is you and your buddy are trading for

2. Explain how it would be beneficial to you to trade.

3. What is this called in economic terms?

4. Have you ever traded household chores with siblings? Other friends?

.

An economy can produce more as a whole when each person specializes and in a task and trades with others for what she is not good at producing….

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Give examples of how individuals and businesses specialize

• What is Specialization? • Devotion of resources to a task

• What is Division of labor? • Splitting up work into smaller tasks• With a partner, pick a service that requires specialization give examples

of HOW a business or individual specializes. Explain or draw below the specialization and the division of labor of your service.

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Comparative vs. Absolute Advantage• Comparative advantage: • who has the lower opportunity cost?• Absolute advantage: • a person or economy can produce more of a good or service

with a given amount of time and resources than another• http://www.youtube.com/watch?v=GrY8oymZoe4

• http://theconversation.com/the-economics-of-comparative-advantage-and-usain-bolt-video-7988

• Comparative Advantage leads nations to trade with each other P. 28 Figure 4.3

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Production Possibilities for Bangladesh & USA

Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts? To find out:

1. Calculate the opportunity costs of production for each country2. Determine the comparative advantage for each country3. Determine if the terms of trade are mutually beneficial

Cotton Shirts or Malaria Medicine?

Bangladesh United States

Cotton Shirts (C)

Malaria Medicine (M)

Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts? To find out:

1. Calculate the opportunity costs of production for each country2. Determine the comparative advantage for each country3. Determine if the terms of trade are mutually beneficial

Cotton Shirts or Malaria Medicine?

Bangladesh United States

Cotton Shirts (C)750C = 250M

1C = 1/3M1000C =1000M

1C = 1M

Malaria Medicine (M)

250M = 750C1M = 3C

1000M =1000C1M = 1C

Bangladesh United States

Cotton Shirts (C)

750C = 250M1C = 1/3M

1000C =1000M1C = 1M

Malaria Medicine (M)

250M = 750C1M = 3C

1000M =1000C1M = 1C

The United States has a comparative advantage in

Malaria Medicine (M) because they only give up 1

cotton shirt while Bangladesh must give up 3 cotton shirts to gain 1 unit of

medicine.

Bangladesh has a comparative advantage in Cotton Shirts (C)

because they only give up 1/3 unit of medicine while The United States must give up 1 unit of medicine to

gain 1 cotton shirt.

What is the Opportunity Cost?Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts? To find out:

1. Calculate the opportunity costs of production for each country2. Determine the comparative advantage for each country3. Determine if the terms of trade are mutually beneficial

Bangladesh United States

Cotton Shirts (C)

1C = 2/3M 1C = 1M

Malaria Medicine (M)

1M = 3C 1M = 2C

Pretend the numbers came out differently.

1. Instead of for Bangladesh 1 cotton shirt to 1/3 medicine, it came out 1 Cotton shirt to 2/3 medicine. Is the trade still beneficial? Explain.

2. And instead of for the USA, 1 medicine to 1 cotton shirt, it came out 1 medicine to 2 cotton shirts. Is the trade still beneficial? Explain.

Mutually Beneficial Trade: Both Countries Must Gain

The terms of trade are mutually beneficial as long as they are between the two countries’ opportunity costs.

1. Instead of for Bangladesh 1 cotton shirt to 1/3 medicine, it came out 1 Cotton shirt to 2/3 medicine. Is the trade still beneficial? Explain. Any amount of medicine greater than 1/3 and less than 1 traded for 1 cotton shirt would represent mutually beneficial terms of trade.

2. And instead of for the USA, 1 medicine to 1 cotton shirt, it came out 1 medicine to 2 cotton shirts. Is the trade still beneficial? Explain. Any number of cotton shirts greater than 1 and less than 3 traded for 1 unit of medicine would represent mutually beneficial terms of trade.

Mutually Beneficial Trade: Both Countries Gain

Bangladesh United States

Cotton Shirts (C)

1C = 2/3M 1C = 1M

Malaria Medicine (M)

1M = 3C 1M = 2C

Mutually Beneficial Trade: Both Countries Gain

Tom Hank

Fish

Coconuts

1. Calculate the opportunity costs of production for each country.

2. Determine the comparative advantage for each country

3. Determine if the terms of trade are mutually beneficial

Mutually Beneficial Trade: Both Countries Gain

Tom Hank

Fish 40F = 30Co 10F = 20Co

Coconuts 30Co = 40F 20Co = 10F

1. Calculate the opportunity costs of production for each worker.

2. Determine the comparative advantage for each worker.

3. Determine if the terms of trade are mutually beneficial

Comparative Advantage & Gains from Trade

• The story of Tom & Hank p. 24 figure 4.1• Can both produce fish & coconuts? Sure• Can each specialize in what they do best & trade for

the rest? Definitely• Every fish Tom catches he gives up ¾ of a coconut• Every fish Hank catches he gives up 2 coconuts

» Who is better at catching fish?» Tom (table 4.2 & figure 4.2)» Hank has a higher opportunity cost than Tom if he

catches fish. Tom should fish & trade with Hank for the coconuts.

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Activity: Fish ‘n’ Chips

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Review for Section 1 TestBasic Economic Concepts

• Congratulations! You made it through the first section of AP Macroeconomics.

• The test will have multiple choice questions and 2 free response questions.

• The test is short so know your stuff!!• Best Success!

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