1. Comparative Advantage & Trade
Module 4
Comparative Advantage & Trade

2. Main Ideas
How trade leads to gains for an individual and for national economies. The important distinction between absolute advantage and comparative advantage. How comparative advantage leads to gains from trade in the global marketplace.
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3. Key Economic Concept
The key concept in this module is that anytime two nations (or individuals) have differing opportunity costs of production, there is an opportunity to gain from trade.
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4. I. There Are Gains From Trade
Discussion Questions: Where were your shirts made? What have you eaten today? Who created the food you ate? Why didn’t you perform these tasks on your own? Are we better off because we can focus on being a student while someone else focuses on growing food or manufacturing our clothes?
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5. I. There Are Gains From Trade
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6. I. There Are Gains From Trade
People SPECIALIZE in one part of building an airplane.
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7. II. Comparative Advantage and Gains From Trade
What was the lesson learned in Figure 4.1?
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8. II. Comparative Advantage and Gains From Trade
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9. II. Comparative Advantage and Gains From Trade
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10. II. Comparative Advantage and Gains From Trade
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12. …someone has a comparative advantage at a task if this person can do the task at a LOWER OPPORTUNITY COST than the other person
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13. …someone has a comparative advantage at a task if this person can do the task at a LOWER OPPORTUNITY COST than the other person
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15. …someone has a comparative advantage at a task if this person can do the task at a LOWER OPPORTUNITY COST than the other person
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16. Washing one load of dishes
Absolute advantage …can produce more than the other with the same amount of resources.
Comparative advantage…can produce something at a LOWER opportunity cost than the person/country being compared.bsolute
Washing two load of dishes
Vacuuming ½ of a room
Washing one load of dishes
Vacuuming 1 room
Debbie
Mike
Debbie
Mike
Mike-dishes Debbie Vacuum
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17. Cleaning two jail cells
Cleaning 4/3 of a jail cell
Cleaning ½ of an office
Cleaning ¾ of an office
Hannah
Hannah
Hannah
Andy
Hannah should clean offices and Andy should clean jail cells, and they will finish sooner. The person with the lower opportunity cost should perform the chore.
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18. For every car, the US must give up 1/3 of a computer
For every car, Japan must give up 3/5 of a computer
For every computer, the US must give up three cars
For every computer, Japan must give up 5/3 of a car
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19. United States Japan United States Japan
US should produce cars. Japan should produce computers. Total output will be higher and cost will be lower.
Without comparative advantage there will be fewer goods and services. Less trade or self-sufficiency means a lower standard of living.
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20. II. Comparative Advantage and Gains From Trade-Example
Two states, Oregon and Washington Before trade, both states are self-sufficient in apples and timber and can produce at the levels shown below. Who has the absolute advantage in timber? Apples? Oregon in Timber. Washington in apples Draw the PPC’s for both nations. Assume each is producing and consuming at the midpoint. Draw Oregon on the left with Timber on the vertical axis for both states.
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21. II. Comparative Advantage and Gains From Trade-Example
Draw Oregon on the left with Timber on the vertical axis for both states.
Oregon has 20 timber, 5 apples. Washington has 20 apples, 5 timber.
Total timber production: 25
Total apple production: 25
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22. II. Comparative Advantage and Gains From Trade-Example
How can these states increase output?
The principle of comparative advantage says that total output will be greatest when each good is produced by the state that has the lower opportunity cost.
Washington has comparative advantage in apple production and should specialize in apples.
Oregon should specialize in timber because of their comparative advantage.
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23. II. Comparative Advantage and Gains From Trade-Example
Note that if they specialize, they’ll produce (together) more apples and timber than they had individually without specialization.
In the PPC’s for each state, show the points of specialization.
Total timber production: 40 (all in Oregon)
Total apple production: 40 (all in Washington)
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24. II. Comparative Advantage and Gains From Trade-Example
So now Oregon doesn’t have anything to eat, and Washington doesn’t have any shelter. Maybe a trade is in order?
Oregon will export Timber, Washington will export Apples.
Since each nation would like some of both goods, they will now have to trade.
The original cost conditions in each country will limit the terms of trade.
In Washington 1 apple = .25 timber, so Washington must get more than .25 Timber for each 1 unit of apples exported, or they will not benefit from export.
In Oregon 1 apple costs 4 timber, so Oregon will not give up more than 4 timber to get 1 apple.
The rate of exchange will be somewhere between .25 and 4 timbers for each apple.
Suppose they negotiate a trade where Washington sends 20 apples to Oregon in exchange for 20 timber.
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25. II. Comparative Advantage and Gains From Trade-Example
The rate of exchange will be somewhere between .25 and 4 timbers for each apple.
Suppose they negotiate a trade where Washington sends 20 apples to Oregon in exchange for 20 timber.
Consumption after trade:
Oregon: 20 Timber and 20 Apples
Washington: 20 Timber and 20 Apples
Show these points outside of both PPC’s.
Stress to the students that without trade, each state is constrained by the PPC. But with trade, they are well beyond the PPC.
These chalkboard gains from trade really demonstrate why virtually all economists advocate free and fair trade.
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26. II. Comparative Advantage and Gains From Trade-Example 2
The U.S. and England have the following production possibility curves.
The opportunity cost of 1 unit of Fish in the U.S. is ________________________.
The opportunity cost of 1 unit of Chips in the U.S. is _________________________.
The opportunity cost of 1 unit of Fish in England is _________________________.
The opportunity cost of 1 unit of Chips in England is ________________________.
The U.S. has an absolute advantage in _____________________.
England has an absolute advantage in _____________________.
The U.S. has a comparative advantage in _____________________.
England has a comparative advantage in ___________________
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27. II. Comparative Advantage and Gains From Trade-Example 2
What happens to total world output when the countries specialize and trade?
What is this called?
Are the countries better off? Explain.
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28. Review of Main Ideas
How trade leads to gains for an individual and for national economies.
The important distinction between absolute advantage and comparative advantage.
How comparative advantage leads to gains from trade in the global marketplace.
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