. Chapter 6- Comparative Advantage SECTION 1 © 2001 by Prentice Hall, Inc. Objective – Students will be able to answer questions regarding comparative advantage.

Ricky Ricardo Lucy’s Cuban- American husband drumming on the bongo.

David Ricardo English economist responsible for promoting comparative advantage as the basis of trade. No relation to Ricky Ricardo.

Absolute Advantage v. Comparative Advantage Absolute Advantage –Faster, more, more efficient Comparative Advantage –Lower opportunity cost

Specialization Producing according to comparative advantage

Example Assume David Ricardo and Ricky Ricardo are going to throw a party in exactly one hour. They decide on serving homemade pizzas and cakes. Assume they have like 15 ovens in their apartment and lots of pots and pans. Use the information in the next slide to determine who should produce what.

Example David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr.4 cakes/hr. Make Pizza6 pizzas/hr.8 pizzas/hr.

David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr.4 cakes/hr. Make Pizza6 pizzas/hr.8 pizzas/hr. Who has the absolute advantage in baking cakes? Who has the absolute advantage in making pizza?

David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr.4 cakes/hr. Make Pizza6 pizzas/hr.8 pizzas/hr. Why? Well, because 4 cakes>2 cakes & 8 pizzas>6 pizzas.

David Ricardo Ricky Ricardo Bake Cakes 2 cakes/hr.4 cakes/hr. Make Pizza6 pizzas/hr.8 pizzas/hr. Who has the comparative advantage in baking cakes? Who has the comparative advantage in making pizza?

Why? Ricky only gives up 2 pizzas in order to bake a cake, whereas David gives up 3 pizzas in order to bake a cake.

Example Furthermore, it only cost David 1 /3 of a cake to make a pizza, whereas it costs Ricky ½ of a cake to make a pizza.

Rum Crystal 1 million 100, ,000 30,000 A B 0 C 80,000 40, ,000 Ireland Puerto Rico A B C Crystal Rum ABCABC 1 million 0 700,00030, ,000 ABCABC 80, , ,000

Ireland Puerto Rico Which country has the absolute advantage in the production of Crystal? In the production of Rum? Rum Crystal 1 million 100, ,000 30,000 A B 0 C Rum Crystal 80,000 40, ,000 A B C

Ireland Puerto Rico Which country has the comparative advantage in Crystal? In Rum? Rum Crystal 1 million 100, ,000 30,000 A B 0 C Rum Crystal 80,000 40, ,000 A B C

Puerto Rico There are___steps in figuring out which country has the comparative advantage. 5 Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C

1. Know the definition of comparative advantage One entity can produce something at a LOWER MARGINAL OPPORTUNITY COST than another entity. 2. Set up a table: Ireland Puerto Rico 1 Rum = __Crystal 1 Crystal = __ Rum 1 Crystal = __Rum 3. Go to the Xtremes (X and Y Games) Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C

Puerto Rico 1. Know the definition of comparative advantage 2. Set up a table: Ireland Puerto Rico 1 Rum = __Crystal 1 Crystal = ____ Rum 1 Crystal = __Rum 3. Go to the Xtremes (X and Y Games) 4. Fill in the blanks (starting with Puerto Rico first) /10 5. Circles and Arrows Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C

Puerto Rico We decided that Ireland should produce ALL the crystal and Puerto Rico should produce ALL the rum. How much crystal should Ireland produce? 1 million cases How much rum should Puerto Rico produce?80,000 barrels Should Ireland just hold onto its cases of crystal and Puerto Rico just hold onto its barrels of rum? NO! What should each country do after specialization?Trade Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C

Puerto Rico Consumes Consumes after specialization before Trade Produces Trades and Trade (Point B) Gain from Trade C 1 million -175,000 R 0 +35, ,000 35, ,000 30, , ,000 IRELAND PUERTO RICO C 0 R 80, , ,000175,000 45,000 40, ,000 +5,000 Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C

Puerto Rico Consumes Consumes after specialization before Trade Produces Trades and Trade (Point B) Gain from Trade C 1 million -175,000 R 0 +35, ,000 35, ,000 30, , ,000 IRELAND PUERTO RICO C 0 R 80, , ,000175,000 45,000 40, ,000 +5,000 Plot this column 35, ,000 D D Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland Rum Crystal 80,000 40, ,000 A B C 175,000

Puerto Rico 45, ,000 Which country is obviously better off through this specialization and trade--Ireland or Puerto Rico? Both Countries are!!! Both countries are now outside their own production capabilities. Through specialization and trade all parties are better off. 825,000 Rum Crystal 1 million 100, ,000 30,000 A B 0 C Ireland 35,000 D Rum Crystal 80,000 40, ,000 A B C D

Section 1 Assessment 1.Describe the difference between absolute and comparative advantage. 2. Describe how the idea of comparative advantage encourages specialization and international trade.

Summary: In a paragraph, describe what you have learned today.