Absolute-Advantage-and-Comparative-Advantage

Aim:Howdoesevaluationofcomparativeandabsoluteadvantagehelpexplainwhynationstrade?DoNow:DEFENITIONOFTERMSWhydonationstrade?•“Youcouldsay…thatglobalization,drivennotbyhumangoodnessbutbytheprofitmotive,hasdonefarmoregoodforfarmorepeoplethanalltheforeignaidandsoftloanseverprovidedbywell-intentionedgovernmentsandinternationalagencies.”PaulKrugman,“TheMagicMountain,”NewYorkTimes,January23,2001AdamSmith,TheWealthofNations(oftencalledtheFatherofModernEconomics)Itisthemaximofeveryprudentmasterofafamily,nevertoattempttomakeathomewhatitwillcosthimmoretomakethantobuy.Thetaylordoesnotattempttomakehisownshoes,butbuysthemoftheshoemaker.Theshoemakerdoesnotattempttomakehisownclothes,butemploysataylor.Thefarmerattemptstomakeneithertheonenortheother…Whatisprudenceintheconductofeveryprivatefamily,canscarcebefollyinthatofagreatkingdom.Ifaforeigncountrycansupplyuswithacommoditycheaperthanwecanmakeit,betterbuyitofthemwithsomepartoftheproduceofourownindustry;….(BookIV,Sectionii,12)Whydonationstrade?•Nearlyalleconomictheoriessuggestthatthebenefitsofinternationaltradefarexceedthecosts.•“Specializationandinternationaltradeincreasetheproductivityofanation’sresourcesandallowforgreatertotaloutputthanwouldotherwisebepossible.“McConnellandBrue,16theditionImportantTermstoKnow•Specialization:Divisionoflaborintospecifictasksandrolesintendedtoincreasetheproductivityofworkers.•Globalization:Namefortheprocessofincreasingtheconnectivityandinterdependenceoftheworld'smarketsandbusinesses.•Imports:Goodsandservicespurchasedfromothercountries•Exports:GoodsandservicessoldtoothercountriesAbsoluteAdvantage•Individual–existswhenapersoncanproducemoreofacertaingood/servicethansomeoneelseinthesameamountoftime(orcanproduceagoodusingtheleastamountofresources.)•National–existswhenacountrycanproducemoreofagood/servicethananothercountrycaninthesametimeperiod.IsAbsoluteAdvantagetheonlybasisfortrading?Whatifapersonoranationhasanabsoluteadvantageinproducingeverything….wouldtherestillbeareasontospecializeandtrade?ComparativeAdvantageApersonoranationhasacomparativeadvantageintheproductionofaproductwhenitcanproducetheproductatalowerdomesticopportunitycostthancanatradingpartner.Comparativeadvantageasthebasisfortradeisoneofthemostimportantideasineconomicsandalsooneoftheleastintuitive.ComparativeAdvantage•Comparativeadvantageisthebasisforalltradebetweenindividuals,regions,andnations.•Apersonornationwillspecializeintheproductionofaproductforwhichithasaloweropportunitycostandtradetoobtainthoseproductsforwhichitsopportunitycostishigher.SpecializationandTrade•Gainsfromtradearebasedoncomparativeadvantage,notabsoluteadvantage•Specializationandtradeincreaseproductivitywithinanationandincreaseanation’soutputandstandardofliving.•Everyonecanbenefitwhenpeopletradewithoneanother.Notonlycanpeopleenjoyagreaterquantityofgoodsandservices,buttheycanalsoenjoyagreatervarietyofgoods.BakeCakesMakePizzaMs.Gray2cakes/hr.6pizzas/hr.Mr.Pinson4cakes/hr.8pizzas/hr.Whohastheabsoluteadvantageinproducingcakes?Mr.PinsonWhohastheabsoluteadvantageinproducingpizza?Mr.PinsonWouldMr.Pinsonbebetteroffifhespecializesandtrades?BakeCakesMakePizzaMs.Gray2cakes/hr.(1c=3p)6pizzas/hr.(1p=1/3c)Mr.Pinson4cakes/hr.(1c=2p)8pizzas/hr.(1p=1/2c)Mr.Pinsonshouldspecializeandtradeifhehasacomparativeadvantage(loweropportunitycost)intheproductionofoneoftheproducts.Mr.Pinsonhasaloweropportunitycostinproducingcakes;therefore,heshouldspecializeintheproductionofcakes.Ms.Grayhasaloweropportunitycostinproducingpizza;therefore,sheshouldspecializeintheproductionofpizza.TermsoftradeBakeCakesPinsonwillspecializeincakes.MakePizzaGraywillspecializeinpizzas.Ms.Gray1c=3pForonecake,Graywouldbewillingtopayanythingupto3pizzas.1p=1/3cForonepizza,Graywillwantmorethan1/3cakes.Mr.Pinson1c=2pForonecake,Pinsonwillwantmorethan2pizzas.1p=1/2cForonepizza,Pinsonwouldbewillingtopayanythingupto½cake.HowtoHandleaComparativeAdvantageProblemontheAPExam1.Thequestionwillhaveinformationabouttwonationsproducingtwoofthesameproducts.ThisinformationwillbegiventoyouinaProductionPossibilitiestableoronaProductionPossibilitiescurveormaybeawordproblemform.2.Askwhattypeofproblem:Outputorinput?2.Determinewhichnationorpersonhastheabsoluteadvantageinproducingeachofthetwogoodsorservices.3.Determinewhichnationorpersonhasthecomparativeadvantageinproducingeachofthetwogoodsorservices.–Foreachnation,determinetheopportunitycostofproducingoneunitofeachgood.–Identifythenationthathasthelowestopportunitycostofproducingoneunitofeachgood.Thatnationhasthecomparativeadvantage.4.Determinethetermsoftrade.Eachcountrywillspecializeintheproductionofthegoodinwhichithasthecomparativeadvantageandwillexportthatgood.Itwillimporttheothergood.Thetermsoftradewillbewhateverismutuallybeneficialtothetwocountries.(Theywillwanttobebetteroffaftertradethanbeforetrade.)•IfthecountryexportsGoodA,itwillwantmoreofGoodBthanitwouldgetbeforespecialization.•IfthecountryimportsGoodA,itwillwanttopaylessintermsofGoodBthanitwouldhavetopaybeforespecializationandtrade.Tom’sPPFHank’sPPFQofCoconutsQofCoconutsQofFishQofFish