How does trade lead to gains for an individual or an economy? What is the difference between absolute advantage and comparative advantage? How does comparative advantage lead to gains from trade in the global marketplace?

Comparative Advantage and Gains from Trade Absolute Advantage Comparative Advantage Terms of Trade

It takes you half an hour to type your handwritten paper, whereas it takes your roommate one hour. Furthermore, it takes you 30 minutes to iron a shirt whereas it takes your roommate 10 minutes. 1. Who has an absolute advantage in typing? In ironing? 2. According to absolute advantage, who should specialize in typing? In ironing? 3. What would be the total output of papers and shirts?

Can we increase output through a different arrangement? It takes you half an hour to type your handwritten paper, whereas it takes your roommate one hour. Furthermore, it takes you 30 minutes to iron a shirt whereas it takes your roommate 10 minutes. Can we increase output through a different arrangement?

FORMULAS Output Method Not Chosen (what you are giving up for…) Chosen (what you produce)

Problem Country Wheat Cloth Portugal 10 20 England 20 60 Portugal Opportunity cost of wheat = 20/10 = 2 cloth Opportunity cost of cloth = 10/20 = 1/2 wheat England Opportunity cost of wheat = 60/20 = 3 cloth Opportunity cost of cloth = 20/60 = 1/3 wheat Problem

Answer Portugal should produce wheat: 2 units of wheat to England’s 3 England should produce cloth: 1/3 unit of cloth to ½

Production Possibilities for Two Countries

Production Possibilities for Two Countries Bangladesh United States Cotton Shirts (C) 750 OC = 1000 OC = Malaria Medicine (M) 250

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

Production Possibilities for Two Countries

Production Possibilities for Two Countries Bangladesh United States Cotton Shirts (C) 750C = 250M 1C = 1/3M 1000C =1000M 1C = 1M Malaria Medicine (M) 250M = 750C 1M = 3C 1000M =1000C 1M = 1C Q: Is it beneficial for Bangladesh to trade 200 cotton shirts for 100 units of malaria medicine?

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

Q: Compared to historical levels, why might manufacturing on the decline in the United States?