Absolute & Comparative Advantage How do we determine what to produce?

Absolute Advantage Absolute advantage is when someone is the best at doing something The USA is the best at producing entertainment Nick Saban is the best at coaching college football Lebron James is the best basketball player Are there cases where someone might be the best at something but it’s better for them to not do it?

Comparative Advantage If Lebron James is the best basketball player and the best teacher, while Jenkins is a weak basketball player and a moderate teacher, who should do which task? Comparative Advantage is when a person can produce something at a lower opportunity cost than anyone else.

Comparative Advantage In this scenario: Jenkins has the comparative advantage in teaching because it cost him less (in giving up a weak basketball game) in order to specialize in teaching. Lebron James has the comparative advantage in basketball because it costs him less (in giving up comparatively low teacher pay) to specialize in basketball.

Comparative Advantage To find comparative advantage, DO NOT compare Absolute advantage: ability of an individual, or firm, or country to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources Instead compare their opportunity costs Value of the best alternative

Comparative Advantage USA has an absolute advantage in airplane production and coffee production when compared to Guatemala So why does Guatemala produce significantly more coffee than the USA? Simple, USA has to give up too many airplane producers (a very complex field) to grow coffee.

Before Specialization Example: Salmon and Coffee Hours Worked Production Alaska 4 (making salmon) 5 pounds of salmon 4 (making coffee) 1 pound of coffee Brazil 1 pound of salmon 5 pounds of coffee If Alaska works 8 hours with NO TRADE they have 5lbs salmon and 1lb of coffee If Brazil works for 8 hours with NO TRADE they have 1lb of salmon and 5lbs of coffee

How can the Alaskan make this work to its benefit? After Specialization After Specialization Hours Worked Production Alaska 8 (making salmon) 10 pounds of salmon Brazil 8 (making coffee) 10 pounds of coffee If they specialize in what they make best Alaska spends all it’s time making salmon while Brazil only makes coffee. Alaska produces 10 pounds of salmon, but no coffee. Brazil produces 10 pounds of coffee but no salmon. How can the Alaskan make this work to its benefit?

After Trade: After Trade Coffee Salmon Alaska 5 pounds coffee 5 pounds of salmon Brazil TRADE! If he sells half his salmon to Brazil and uses the money to buy 5 pounds of coffee, he will still have 5 pounds of salmon and now he’ll have 5 pounds of coffee too! Before specialization the Alaskan only had 1 pound of coffee—so in in the end, he comes out with an extra 4 pounds of coffee and didn’t have to do any additional work!

Sample Problems Who has Absolute Advantage in cars? Computers United States 16 8 Japan 6 Who has Absolute Advantage in cars? United States Who has Absolute Advantage in computers?

Sample Problems Cars Computers United States 16 8 Japan 6 Who has Comparative Advantage in computers? Japan. Why?

Sample Problems Cars Computers United States 16 8 Japan 6 United States’ opportunity cost of computers: 16 2 ----- = ----- = 2 cars 8 1 Japan’s opportunity cost of computers: 8 4 ---- = ----- = 1.33 cars 6 3 HINT: always put the item asked about in the denominator

Sample Problems Who has comparative advantage in cars? Computers United States 16 8 Japan 6 Who has comparative advantage in cars? United States has the comparative advantage because they only have to give up 1/2 of a computer versus 3/4 that Japan has to give up, in order to produce 1 car.

Sample Problems Cars Computers United States 16 8 Japan 6 United States’ opportunity cost of specializing in cars: 8 1 ----- = ----- = 1/2 of a computer 16 2 Japan’s opportunity cost of specializing in cars: 6 3 ---- = ----- = 3/4 of a computer 8 4

Video Clip Economics in 60 Seconds http://www.youtube.com/watch?v=38hvvAzgXZY

You Try Who has absolute advantage in bananas? Rice Fiji 10 5 China 2 Who has absolute advantage in bananas? Who has absolute advantage in rice? Who has comparative advantage in rice? Who has comparative advantage in bananas?

You Try Who has absolute advantage in bananas? Rice Fiji 10 5 China 2 Who has absolute advantage in bananas? Neither-both produce 10 bananas Who has absolute advantage in rice? Fiji has absolute advantage (5-2)

Comparative Advantage - Bananas Rice Fiji 10 5 China 2 China only gives up 1/5 rice whereas Fiji has to give up 1/2 rice to produce 1 banana. Fiji’s opportunity cost of bananas: 5 1 ----- = ----- = 1/2 rice 10 2 China’s opportunity cost of bananas: 2 1 ---- = ----- = 1/5 rice 10 5

Comparative Advantage - Rice Bananas Rice Fiji 10 5 China 2 Fiji only gives up 2 bananas whereas China has to give up 5 bananas to produce 1 rice. Fiji’s opportunity cost of Rice: 10 2 ----- = ----- = 2 bananas 5 1 China’s opportunity cost of Rice: 10 5 ---- = ----- = 5 bananas 2 1

Sample Problems A look at the worksheet (Lesson 1, Activity 2) Mike Debbie Vacuuming 60 min. 45 min. Wash dishes 30 min. 45 min. What is Mike’s opp. cost of vacuuming in terms of washing dishes? (In other words, how many loads of dishes does he have to give up to vacuum the room) Answer—2 loads of dishes (60 min./30 min.) = 2 Let’s try another one

Sample Problems Mike Debbie Vacuuming 60 min. 45 min. Wash dishes 30 min. 45 min. What is Mike’s opp. cost of doing dishes in terms of vacuuming? (In other words, how much vacuuming does he have to give up to do dishes) Answer— 1/2 of a room vacuumed (30 min./60 min.) = .5 What about Debbie? She has to give up 1 room vacuumed for 1 load of dishes (45/45=1)

Sample Problems So if Debbie has to give up 1 room vacuumed to do a load of dishes meanwhile Mike has to give up ½ a room to do a load of dishes; who has the comparative advantage of doing dishes? Mike does because it only costs him ½ a room to Debbie’s 1 room.