1. DO NOW
Why do people and countries trade as opposed to just making everything themselves?

2. Comparative and Absolute Advantage

3. Why do we trade? Absolute Advantage
-1 firm is more efficient making a product than another.
Ex: In 1 hour, Mr. Itokazu can make 5 computers. I can make 3. Ito has A.A. in Computers
* What if 1 country had Abs. Advantage in everything?

4. Why do we trade? Comparative Advantage
- when 1 country can make a product at a lower Opportunity Cost than another.
*Countries Specialize in the good with the lowest Opportunity Cost!
Think about this example……

5. Why do we trade? America and China both make Toys and Computers.
-In 1 hour, America can make 10 toys. China can make 9.
In 1 hour, America can make 10 computers. China can make 3.
 Let’s draw both of their PPFs…

6. For Toys: USA can make more per hour = has ABSOLUTE advantage
Units produced (Output) per hour
Toys
Computers
America 10
China 9 3
For Toys: USA can make more per hour = has ABSOLUTE advantage
For Computers: USA can make more per hour = has Abs. Adv.

7. Toys
Computers
America 10
China 9 3
For Comparative, we must calculate Opportunity Costs…
Toys
Computers
America
1 (com)
1 (toy)
China
1/3 (com)
3 (toys)

8. Toys
Computers
America
1 (com)
1 (toy)
China
1/3 (com)
3 (toys)
Firm have Comparative Adv. And will specialize in good with the LOWEST Opportunity Cost
toys: 1/3<1 = China has CA
Comps: 1<3 = USA has CA
*None can have CA in Both!

9. Terms of Trade
For trade to be helpful to BOTH, the terms of trade must be between the OC’s.
Ex: OC for 1 toy for US is 1 comp. For China, 1/3 of a comp
 Good if trade is 1 toy for 2/3 comp. (both consume beyond PPF)

10. Output vs. input can ask about output or input: Example of Output:
“Units produced per hour”
Example of input:
“hours needed to produce one unit of…”
 consider this…

11. Toys Computers America 10 China 9 3
Number of hours (Input) needed to produce one unit of…
Toys
Computers
America 10
China 9 3
Toys: China more efficient=has A.A.
Comp: China more efficient=has AA

12. Toys
Computers
America 10
China 9 3
Who has comparative advantage in Toys, Computers? find O.C.!
Toys
Computers
America 1
China 3
1/3

13. Toys
Computers
America 1
China 3
1/3
Toys: 1<3  USA has C.A.
Comps: 1/3 < 1  China has C.A.

14. Hours needed to make 1 (Input)
Toys
Computers
America 10
China 9 3
Toys
Computers
America 1
China
9/3
3/9
Units produced per hour (Output)
Toys
Computers
America 10
China 9 3
Toys
Computers
America
10/10
China
3/9
9/3

15. Shortcut!! Step 1: Determine if it’s an Output or Input question.
Step 2: Figure which is more efficient = Absolute Advantage
Step 3: Find O.C. Specialize in good w/ lowest OC.
Step 4: Terms of trade b/w OC

16. Units produced per worker
Cars
Shirts
Germany 6 12
Italy 2 10
Who has the Absolute advantage in Cars? Shirts?
Who has Comparative adv. in each? What’s a good Trade Term?