Absolute and Comparative Advantage AP Macroeconomics Coach Saucedo Manvel High School

Nations trade for several reasons They want goods Think of what we would do without if we didn’t trade. To make money.

Trade-deficit or surplus Trade surplus-exports exceed imports. Trade deficit-imports exceed exports. The USA has a trade deficit. A trade deficit=exports-imports This does NOT mean the US government owes other countries money. A trade is between companies within a country. The national debt is different.

David Ricardo Ricardo argued that there is mutual benefit from trade even if one party (e.g. resource-rich country, highly-skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled laborer). As long as each concentrates on the activities where it has relative productivity advantage.

Absolute and Comparative Advantage I have an absolute advantage, if I produce faster, more and more efficient If I can produce a good or service at a lower opportunity cost than you then I have a comparative advantage. Production based on comparative advantage is Specialization.

Absolute and Comparative Advantage Let's use our tropical island example to identify who has absolute and comparative advantage in the production of fish and coconuts.

Absolute and Comparative Advantage In one hour Tom can cut down 16 coconuts or catch 8 fish. In one hour Wilson the volleyball can cut down 21 coconuts or catch 7 fish.

Absolute Advantage-output Make a chart like the one to the right You can produce more that the other person/country. Coconuts? Fish? Tom Wilson Coconuts 16 21 fish 8 7

Absolute and Comparative Advantage So who has the absolute and comparative advantage in what product. Tom Wilson Coconuts/hour (A) 16 21 Fish/hour (B) 8 7

Comparative Advantage Coconuts: (other goes over) Tom 8/16= .5 Wilson 7/21=.33 Fish: Other goes over) Tom 16/8= 2 Wilson 21/7= 3 The person with the lowest number should produce that item. Why? They are giving up the least of the other item to produce their item. Tom Wilson Coconuts (A) 16 21 Fish (B) 8 7

The bottom line is that it is comparative advantage (opportunity cost) and not absolute advantage that yields an incentive for specialization and trade. Now—Can Tom and Wilson trade with each other?

Example David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr. 4 cakes/hr. Make Pizza 6 pizzas/hr. 8 pizzas/hr.

Example David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr. 4 cakes/hr. Make Pizza 6 pizzas/hr. 8 pizzas/hr. Who has the absolute advantage in baking cakes? Who has the absolute advantage in making pizza?

Example David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr. 4 cakes/hr. Make Pizza 6 pizzas/hr. 8 pizzas/hr. Why? Well, because 4 cakes>2 cakes & 8 pizzas>6 pizzas.

Example David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr. 4 cakes/hr. Make Pizza 6 pizzas/hr. 8 pizzas/hr. Who has the comparative advantage in baking cakes? Who has the comparative advantage in making pizza?

Example Who has the comparative advantage in baking cakes? Who has the comparative advantage in making pizza?

Using a graph-another way to illustrate the problem. Convert to a chart.

Output and input questions Examples again