Productivity, Absolute Advantage and Comparative Advantage, Specialization and Trade Unit 1 Lesson 3 by Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education, New York, N.Y.

Objectives Define comparative advantage and absolute advantage. Describe and give examples of the law of comparative advantage. Explain how both parties in a trade gain from voluntary exchange. Define specialization and exchange. Use data to determine absolute and comparative advantage.

Introduction Activity 1-3 introduces absolute advantage and comparative advantage. –Concepts will be covered in more detail in the international-trade unit. People trade because both parties stand to benefit when they engage in voluntary exchanges.

Productivity Ratio of the amount of goods and services produced (output) per unit of productive resources used (input). As a ratio, productivity can be increased by: producing more goods and services with the same amount of resources or by producing the same amount of goods and services with fewer resources.

Productivity Personal and national standards of living are directly related to labor productivity. The greater an individual’s labor productivity, the higher wage that individual can command. People must produce more per person if they are to receive more per person. Individual workers can increase productivity by investing in education and training (human capital).

Participate in a simulation that will demonstrate: How productivity is calculated The factors that can increase productivity Work in teams of four to produce pizzas (made of paper).

How to make a pizza: –Trace the template (a small paper plate) on a piece of 8.5″ x 11″ paper. –Cut out the circle. –Draw 10 pepperoni pieces, about 1″ in diameter, on the pizza, using the red marker. –Draw 15 black olive slices, ½″ to ¾″ in diameter, on the pizza, using the black marker.

Each round will be three minutes long. At the end of each round, quality control experts will determine if pizzas meet standards. Complete the data chart (Activity 8.1). Round 1: –Each employee will work alone. –Employees must complete one pizza before moving on to the next.

Thoughts on how to improve productivity? Round 2: Assign each employee a different task. You may work on more than one pizza at a time. You are limited to the same resources as in Round 1.

Thoughts on how to improve productivity? Round 3: Each team may acquire a capital good: a machine that pre-cuts pizza dough (paper plates). Machine rental is $2.50 per round. Reorganize the factory.

How was productivity calculated? Labor productivity = output per worker over a set time What happened to productivity between Round 1 and Round 2, and between Round 2 and Round 3? Why did this occur? What happened to quality between Round 2 and Round 3? What effect did investing in capital goods (the pizza-cutting machine) have on productivity? What effect did increased productivity have on average costs (row 10, Activity 8.1)? Why is this important?

What effect will increased productivity in the pizza factory have on wages? What happens if labor productivity increases in the overall economy? What costs were incurred by attempts to increase productivity? What are the advantages and disadvantages of specialization and division of labor? What else could the pizza factory do to increase productivity? What should a company consider before investing in capital, such as the pizza-cutting machine?

Factors That Increased Productivity Specialization/division of labor –Assigning small, repeatable tasks at which workers gain expertise, as in Round 2 –Results in more output per unit of labor Increase in human capital –Acquired through education/training, displayed in all three rounds Investment in capital goods –Tools/machines/factories as in Round 3 Technology

Comparative advantage is a powerful concept that helps explain how mutual benefits can occur from exchange. –A nation and an individual have a comparative advantage when they can make one or more products at a lower opportunity cost than another nation or individual. –When producers specialize in the lower-cost product, they can make additional goods. Which they can trade to other producers for goods that would have been more costly to make. –To determine a comparative advantage, costs must be measured in terms of what other products must be forgone to make particular product. This relative measure is a subtle, difficult and very important idea to understand. –A nation’s or an individual’s comparative advantage will change as the opportunity costs of products made available by different trading partners change.

Absolute Advantage and Comparative Advantage What would life be like, if every person had to be totally self-sufficient and could not specialize and trade. You always have to remember that individuals, not nations, trade. However, specialization and trade can be accomplished both domestically and internationally. The more we trade, the better off we all are.

Absolute Advantage and Comparative Advantage ABSOLUTE ADVANTAGE –One nation can produce more output with the same resources as the other. COMPARATIVE ADVANTAGE –One nation can produce a good at a lower opportunity cost than the other. EXAMPLES OF COMPARATIVE ADVANTAGE –Lawyer and secretary –Doctor and nurse

Absolute Advantage and Comparative Advantage We discussed earlier the idea of a lawyer hiring a secretary in the field of word processing. –Remember we stated that the opportunity cost of the lawyer’s time spent as a secretary is very high, perhaps $100 or more. The lawyer could even hire more than one secretary for this amount and still come out ahead. The doctor/nurse situation is the same as the lawyer/secretary situation.

Determining Comparative Advantage (Output Method) 1. Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Should Japan specialize in CDs or beef? 6. Should Canada specialize in CDs or beef? Neither country Canada Japan Canada CD’s Beef

Determining Comparative Advantage (Input Method) 1. Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Which country should specialize in CD production? 6. Which country should specialize in producing beef? Mexico Japan Mexico Japan Mexico

Activity 1-3 You will be doing an activity that illustrates the same concept as it relates to comparative advantage using inputs (minutes or hours to produce a good) and outputs (number of goods produced per hour or per minute). The key is that if one party trades the good for which it has the lower opportunity cost for the good for which the other party has the lower opportunity cost, both parties gain.