Comparative advantage Today: An introduction to the advantages of trade

Correction from last lecture (in bold): Example What is the present value of a $12,100 payment to be received two years from now if the interest rate is 10%? Plug in M = $12,100, r = 0.1, and T = 2 PV = $10,000

Some reminders for Test 1 You will have 45 minutes to complete the test If you are late, you will have less than 45 minutes Read all of the information regarding tests in the syllabus before arrival Make sure you have a calculator that is allowed in the syllabus

Some reminders for Test 1 Tentative test format 12 multiple-choice questions (worth 1 point each) 1 question that you will need to write out the answer (worth 5 points) If your test does not have all questions, please ask for another copy Some questions require calculations; others test your understanding of the concepts

Some reminders for Test 1 Rosemarie and I should be here to proctor the test If for any reason I am not here, the proctor’s word is final on any issues that may come up during the test Any suspected cheating will be reported to the relevant authorities

Some reminders for Test 1 Any reason will be accepted for missing any test, but you are responsible for the consequences as listed in the syllabus Make sure that you have everything that you need for the test before you arrive for the test, including the correct Scantron BUBBLE IN THE CORRECT FORM ON YOUR SCANTRON

Last time… …we wrapped up the invisible hand closed However, we only looked at markets that could be within a closed economy Idea for today: If we open up more trade possibilities, could we “make the economic pie” bigger?

Today Begin Unit 3 Production possibilities Absolute advantage Comparative advantage More review for Test 1

Becky’s linear production possibilities curve

What points are attainable? What points are efficient?

Attainable and efficient points Efficient points Any point on the production possibility curve These points are efficient, since additional production of one good necessarily means that another good has lower production Attainable points F/B define an attainable point to be “any combination of goods that can be produced using currently available resources” (p. 43)

Back to Becky Efficient points: w, x, y, z, v Attainable points: t, w, x, y, z, v Unattainable point: u

Next, let’s look at a two- person economy Suppose that Barbara and Sherry have the Production Possibility Curves (PPCs) as shown

Next, let’s look at a two- person economy Barbara can do one of the following: Copy 50 tests if she does not type letters Type 25 letters and copy no tests Something in between

Next, let’s look at a two- person economy Sherry can do one of the following: Copy 25 tests and do nothing else Type 50 letters and do nothing else Something in between

Opportunity cost How much of one activity needs to be given up in order to do one more of the other? Example: Barbara could type one less letter in order to copy two more tests

Absolute advantage and comparative advantage Absolute advantage “One person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person” (F/B p. 36) Comparative advantage “One person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost” (F/B p. 36)

Example for next week Productivity in pizza production Productivity in salad production Greg20 pizzas cooked per hour 10 salads made per hour David16 pizzas cooked per hour 4 salads made per hour

Comparative advantage Before we can determine comparative advantage, we must ask about each person “how much of ____ must I give up in order to produce an additional ____?” In other words, we need to determine the opportunity cost of making one more pizza or one more salad for both Greg and David

Drop units to save space For next week Think about opportunity cost Example: How many pizzas does Greg have to give up making to make an additional salad? Productivity in pizza production Productivity in salad production Greg20 / hour10 / hour David16 / hour4 / hour

Summary Monday: Test 1 Today’s lecture Individual production possibilities curve We often assume linearity for simplicity Recall meaning of opportunity cost Absolute advantage versus comparative advantage