Module Comparative Advantage and Trade 4 KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: How trade leads to gains for an individual or an economy The difference between absolute advantage and comparative advantage How comparative advantage leads to gains from trade in the global marketplace

Gains from Trade Trade Gains from trade Specialization The importance of markets I. There Are Gains From Trade   Ask the students who made their shoes? What have they eaten today? Who grew the food they ate? Why didn’t the students perform these tasks themselves? Are we better off because we can focus on being a student while someone else focuses on growing food or manufacturing our Fishes? A Trip to the Dentist Everyone has been to the dentist and we have all had an experience similar to this: You arrive, and are greeted by a receptionist. A hygienist takes x-rays of your mouth, then cleans and polishes your teeth. In the last five minutes of your visit, the actual dentist shows up. He/she inspects the work of the hygienist and asks if the hygienist has found anything out of the ordinary in your mouth. Why doesn’t the dentist perform all of these tasks? Isn’t he/she qualified to greet you at the door, take the x-rays, clean and polish your teeth and determine if there are any problems? What is the dentist doing while you spend your time with the hygienist? He or she is doing extractions, cosmetic surgery, root canals, etc. You know, the stuff that actually requires a medical degree to perform. So if your dentist performed all of the tasks that go into a typical visit to the dentist’s office, much of the specialized work would go undone. By employing a receptionist and a hygienist, all three persons can specialize and much more production is done.

Comparative Advantage and Gains from Trade Terms of Trade Absolute Advantage

Production Possibilities for Two Countries

Production Possibilities for Two Countries Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts? To find out: 1. Calculate the opportunity costs of production for each country 2. Determine the comparative advantage for each country 3. Determine if the terms of trade are mutually beneficial

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

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 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

Figure 4.1 Production Possibilities for Two Castaways Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Table 4.1 Tom’s and Hank’s Opportunity Costs of Fish and Coconuts Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Table 4.2 How the Castaways Gain from Trade Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 4.2 Comparative Advantage and Gains from Trade Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 4.3 Comparative Advantage and International Trade Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers