SPECIALIZATION AND COMPARATIVE ADVANTAGE CHAPTER 5

SPECIALIZATION DEFINED THE USE OF THE RESOURCES OF AN INDIVIDUAL, A FIRM, A REGION, OR A NATION TO CONCENTRATE PRODUCTION ON ONE OR A SMALL NUMBER OF GOODS AND SERVICES. (SPECIALIZATION MAKES SENSE WHEN A NATION CAN TRADE THE GOOD IT SPECIALIZES IN FOR OTHER GOODS IT DOES NOT SPECIALIZE IN PRODUCING.)

COMPARATIVE COSTS THE US AND MEXICO PRODUCE AVOCADOS AND SOYBEANS ACCORDING TO THE PPT’S BELOW MEXICO PRODUCTABCDE AVOCADOS SOYBEANS USA PRODUCT ABCDE AVOCADOS SOYBEANS

MEXICO Product ABCDE Avocados Soybeans USA Product ABCDE Avocados Soybeans Comparing the costs (use of input resources) shows that the USA can produce more soybeans and more avocados than Mexico. The USA has an ABSOLUTE ADVANTAGE in producing both goods. In other words, the USA can produce more avocados and soybeans using the same resources. We use our resources more efficiently.

MEXICO Product ABCDE Avocados Soybeans USA Product ABCDE Avocados Soybeans Should the USA specialize in the production of soybeans and avocados since we can produce more of them than Mexico? To answer that question analyze the comparative costs of producing the products in each country.

MEXICO Product ABCDE Avocados Soybeans USA Product ABCDE Avocados Soybeans In Mexico, 5 tons of soybeans must be sacrificed to produce 20 tons of avocados. The 5 to 20 ratio is simplified to: 1S = 4A. In the USA it costs 10 tons of soybeans to obtain 30 tons of avocados. The 10 to 30 ratio is simplified to 1S = 3A. The USA has a COMPARATIVE ADVANTAGE over Mexico in soybean production. Our opportunity cost is lower than our potential trading partner.

MEXICO Product ABCDE Avocados Soybean USA Product ABCDE Avocados Soybeans In Mexico, one ton of avocados cost ¼ ton of soybeans. In the USA, 1 ton of avocados costs 1/3 ton of soybeans. Mexico has a COMPARATIVE ADVANTAGE in the production of avocados. They can produce avocados more efficiently than us.

SOYBEANSAVOCADOS MEXICO: MUST GIVE UP 4 TONS OF AVOCADOS TO GET 1 TON OF SOYBEANS. USA: MUST GIVE UP 3 TONS OF AVOCADOS TO GET 1 TON OF SOYBEANS. COMPARATIVE ADVANTAGE: USA MEXICO: MUST GIVE UP ¼ TON OF SOYBEANS TO GET 1 TON OF AVOCADOS. USA: MUST GIVE UP 1/3 TON OF SOYBEANS TO GET 1 TON OF AVOCADOS. COMPARATIVE ADVANTAGE: MEXICO

TERMS OF TRADE TRADE BETWEEN NATIONS OCCURS WHEN EACH NATION BENEFITS MORE FROM TRADE THAN FROM DOMESTIC PRODUCTION ALONE. THE “TERMS OF TRADE” IS THE AGREED UPON COST OF DOING BUSINESS WITH EACH OTHER. (I AGREE TO GIVE UP ________ SOYBEANS IN ORDER TO GET __________ AVOCADOS.) THE TERMS ARE AGREED UPON THROUGH NEGOTIATIONS.

TERMS OF TRADE THROUGH NEGOTIATIONS MEXICO AND THE USA AGREE TO TRADE AVOCADOS AND SOYBEANS AT THE RATE OF 1 TON OF SOYBEANS FOR 3 ½ TONS OF AVOCADOS. THOSE TERMS WOULD BE AGREED TO BECAUSE THEY ARE BETTER THAN THE COMPARATIVE COSTS OF DOMESTIC PRODUCTION.

TERMS OF TRADE THE US GETS 3 ½ TONS OF AVOCADOS FROM MEXICO AND GIVES MEXICO 1 TON OF SOYBEANS. THAT RATE IS BETTER THAN ITS OWN DOMESTIC COST OF 3 TONS OF AVOCADOS FOR 1 TON OF SOYBEANS. USA Product ABCDE Avocados Soybeans

TERMS OF TRADE MEXICO CAN GET 1 TON OF SOYBEANS FOR 3 ½ TONS OF AVOCADOS. THAT RATE IS BETTER THAN THE 4 TONS IT WOULD GIVE UP IF IT PRODUCED SOYBEANS ITSELF. MEXICO ProductABCDE Avocados Soybeans

GAINS FROM SPECIALIZATION AND TRADE IF EACH NATION FELT THAT POSITION C WAS BEST FOR THEIR COUNTRY’S NEEDS AND WANTS, THEY WOULD TRY TO IMPROVE UPON THOSE NUMBERS THROUGH TRADE. USA Product ABCDE Avocados Soybeans MEXICO ProductABCDE Avocados Soybeans

GAINS FROM SPECIALIZATION AND TRADE IF MEXICO SPECIALIZES IN AVOCADO PRODUCTION THEY CAN PRODUCE 60 TONS OF AVOCADOS. IF THEY TRADE WITH THE USA AT A RATIO OF 3 ½ TONS OF AVOCADOS IN EXCHANGE FOR 1 TON OF SOYBEANS THEY CAN TRADE 35 TONS OF AVOCADOS FOR 10 TONS OF SOYBEANS. MEXICO WOULD BE LEFT WITH 25 TONS OF AVOCADOS AFTER SPECIALIZATION AND TRADE. ONE TON OF AVOCADOS BETTER THAN THEIR SOCIETY’S IDEAL LEVEL AT POSITION C.

GAINS FROM SPECIALIZATION AND TRADE IF THE USA SPECIALIZED IN SOYBEAN PRODUCTION IT COULD PRODUCE 30 TONS OF SOYBEANS. IF WE TRADE WITH MEXICO SO THAT WE RECEIVE 3 ½ TONS OF AVOCADOS FOR 1 TON OF SOYBEANS. WE CAN GIVE MEXICO 10 TONS OF SOYBEANS AND GET 35 TONS OF AVOCADOS. WE WOULD BE LEFT WITH 20 TONS OF SOYBEANS, 1 TON BETTER THAN OUR IDEAL LEVEL AT POSITION C.

COUNTRY OUTPUTS BEFORE SPECIALIZ ATION OUTPUTS AFTER SPECIALIZ AITON AMOUNTS TRADED OUTPUTS AVAILABLE AFTER TRADE GAINS FROM SPECIALIZ ATION AND TRADE MEXICO 24 avocados 60 avocados -35 avocados 25 avocados 1 avocados 9 soybeans 0 soybeans +10 soybeans 10 soybeans 1 soybeans USA 33 avocados 0 avocados +35 avocados 35 avocados 2 avocados 19 soybeans 30 soybeans -10 soybeans 20 soybeans 1 soybeans Through specialization and international trade a nation can overcome the production constraints imposed by its domestic PPT and PPC!

AVOCADOS X * SOY BEANS UNITED STATES OF AMERICA Through trade we can achieve beyond our capabilities to produce

AVOCADOS SOY BEANS X * MEXICO Through trade we can achieve beyond our capabilities to produce