ROLL CALL Would you rather have a Coke or Pepsi?

MODULE 4 COMPARATIVE ADVANTAGE AND TRADE 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

David Riccardo English Economist who first proposed the idea Of Comparative Advantage as a basis of trade.

What are the Gains from Trade? Trade: allows higher standard of living Gains from trade: people can get goods and services they could not get by being self-sufficient Specialization : people specialize in the task they are good at performing. This leads to more production and efficiency. The importance of markets: Competition leads to higher quality and cheaper prices.

Can you make a pencil?

Unit 1 : MicroeconomicsVisual 1.2 National Council on Economic Educationhttp://apeconomics.ncee.net Possibilities Curve Production

Comparative Advantage v. Absolute Advantage Comparative Advantage: An country has comparative advantage when the opportunity cost of producing the good or service is lower than the other country. Absolute Advantage: A country has absolute advantage when they can produce MORE of a good or service with a given amount of time and resources. NOTE: Having absolute advantage is not the same things has having COMPARATIVE advantage.

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 country 2. Determine the comparative advantage for each country 3. Determine if the terms of trade are mutually beneficial Production Possibilities for Two Countries

BangladeshUnited States Cotton Shirts (C) 750C = 250M 1C = 1/3M 1000C =1000M 1C = 1M Malaria Medicine (M) 250M = 750C 1M = 3C 1000M =1000C 1M = 1C Production Possibilities for Two Countries

BangladeshUnited States Cotton Shirts (C) 750C = 250M 1C = 1/3M 1000C =1000M 1C = 1M Malaria Medicine (M) 250M = 750C 1M = 3C 1000M =1000C 1M = 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. Production Possibilities for Two Countries

BangladeshUnited States Cotton Shirts (C) 750C = 250M 1C = 1/3M 1000C =1000M 1C = 1M Malaria Medicine (M) 250M = 750C 1M = 3C 1000M =1000C 1M = 1C The terms of trade are mutually beneficial as long as they are between the two countries’ opportunity costs. For example, any amount of medicine greater than 1/3 and less than 1 traded for 1 cotton shirt would represent mutually beneficial terms of trade. Likewise, 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. Production Possibilities for Two Countries

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Output Method and Input Method Watch and take notes. Practice

Distinguishing input from output problems. An OUTPUT problem presents the data as products produced given a set of resources. (ex. Number of pens produced) An INPUT problem presents the data as amount of resources needed to produce a fixed amount of output. (ex. Number of labor hours to produce 1 bushel) When identifying absolute advantage, input problems change the scenario from who can produce the most to who can produce a given product with the least amount of resources.

Determining Comparative Advantage (Output Method) Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Should Japan specialize in CDs or beef? 6. Should Canada specialize in CDs or beef

Stop!!!!!!!!!!!!!!!!!!!!!!!!!!-- Part B Terms of Trade: Set after comparative advantage is determined. It indicates the rate at which one good can be exchanged for another good. Remember- nations can’t have a comparative advantage in the production of the same good. If the PPCs of both nations have the same slope, then neither country has a comparative advantage in either good– although one might have the absolute advantage in making both goods

AP Exam Tip The producer with the absolute advantage can produce the largest quantity of the good. However, it is the producer who has comparative advantage and not necessarily the one with absolute advantage who should specialize in the production of that good to achieve mutual gains from trade. The people of that country will benefit when comparative advantage is implemented.

2003 FRQ Practice Assume that two countries, Atlantis and Xanadu, have equal amounts of resources. Atlantis can produce 30 cars or 10 tractors or any combination, as shown by the line MN in the figure above. Xanadu can produce 20 cars or 40 tractors or any combination, as shown by the line PQ in the figure above. (a) Which country has an absolute advantage in the production of tractors? Explain how you determined your answer. (b) Which country has a comparative advantage in the production of cars? Using the concept of opportunity cost, explain how you determined your answer. (c) If the two countries specialize and trade with each other, which country will import cars? Explain why. (d) If the terms of trade are such that one car can be exchanged for one tractor, explain how Atlantis will benefit from such trade

Welker’s Wikinomics ive+advantage ive+advantage

Unit 1 : MicroeconomicsVisual 1.1 National Council on Economic Educationhttp://apeconomics.ncee.net The Economic Way of Thinking Everything has a cost. People choose for good reasons. Incentives matter. People create economic systems to influence choices and incentives. People gain from voluntary trade. Economic thinking is marginal thinking. The value of a good or service is affected by people’s choices. Economic actions create secondary effects. The test of a theory is its ability to predict correctly.