1. MBMC Comparative Advantage: The Basis for Exchange Comparative Advantage: The Basis for Exchange

2. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 2 Exchange and Opportunity Cost Absolute Advantage One person has an absolute advantage over another if he takes fewer hours to perform a task than the other person

3. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 3 Exchange and Opportunity Cost Comparative Advantage One person has a comparative advantage over another if his opportunity cost of performing a task is lower than the other person’s opportunity cost

4. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 4 Exchange and Opportunity Cost The Principle of Comparative Advantage Should Paula update her own web page? Time to update web page Time to complete bicycle repair Paula 20 minutes 10 minutes Beth 30 minutes

5. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 5 Opportunity Costs for Paula and Beth The Principle of Comparative Advantage Should Paula update her own web page? Opportunity Cost of updating a web page Opportunity Cost of a bicycle repair Paula 2 bicycle repairs 0.5 web page updates Beth 1 bicycle repair 1 web page update

6. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 6 Exchange and Opportunity Cost The Principle of Comparative Advantage Should Paula update her own web page?  How many web pages and bicycle repairs can Paula and Beth produce a day if they both work eight hour days?

7. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 7 Exchange and Opportunity Cost The Principle of Comparative Advantage Should Barb update her own web page? Productivity in programming Productivity in bicycle repair Pat 2 web page updates per hour 1 repair/hour Barb 3 web page updates per hour 3 repairs/hour

8. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 8 Exchange and Opportunity Cost The Principle of Comparative Advantage Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest

9. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 9 Sources of Comparative Advantage Individual Inborn talent Education Training Experience Natural Endowments Acquired Endowments Superior Knowledge

10. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 10 Exchange and Opportunity Cost Question Televisions and video cassette recorders were developed and first produced in the U.S. Why did the U.S. fail to retain its lead in these markets?

11. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 11 Comparative Advantage and Production Possibilities The Production Possibilities Curve Assume  A small economy that: oProduces only two goods - coffee and nuts oHas only one worker who works 6 hrs/day

12. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 12 Country A’s Production Possibilities Coffee (m lb/day) Nuts m(lb/day) A B C D 24 0 16 8 4812

13. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 13 Country B’s Production Possibilities Curve 0 Nuts (lb/day) How Individual Productivity Affects the Slope and Position of the Production Possibilities Curve Coffee (lb/day) 4 8 816 A B C D 12 24

14. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 14 Individual Production Possibilities Curves Compared Nuts (lb/day) 0 12 24 Country B’s PPC B has an absolute and comparative advantage in gathering nuts 24 12 Country A’s PPC A has an absolute and comparative advantage in gathering coffee Coffee (‘000 lb/day)

15. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 15 Production With Specialization Nuts (lb/day) 0 12 24 1224 A’s Production Possibilities Curve B’s comparative advantage is in nuts so he specializes in nuts and produces 24 m lbs A’s comparative advantage is in coffee so it specializes in coffee and produces 24 m lbs B gives A 12 lbs of coffee for 12 lbs of nuts E B’s Production Possibilities Curve Coffee (lb/day)

16. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 16 Production Possibilities Curve For a Large Economy Nuts (1000s of lb/day) Assume: An economy that produces only two goods, coffee and nuts 100 80 Why would the Production Possibilities Curve have an outward bow? Coffee (1000s of lb/day) E A B C D 15 20 90 95 203075 77

17. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 17 The Principle of Increasing Opportunity Cost (“The Low-Hanging-Fruit Principle”) In expanding the production of any good, first employ those resources with the lowest opportunity costs, and only afterward turn to resources with higher opportunity costs Comparative Advantage and Production Possibilities

18. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 18 Economic Growth: An Outward Shift in the Economy’s PPC Coffee (1000s of lb/day) Nuts (1000s of lb/day) Original PPC New PPC Factors Shifting the PPC 1. Increases in productive resources (i.e. labor or capital) 2. Improvements in knowledge and technology

19. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 19 Factors That Shift The Economy’s Production Possibilities Curve Increasing Productive Resources Investment in new factories and equipment Population growth Improvements in knowledge and technology Increasing education Gains from specialization

20. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 20 Factors That Shift The Economy’s Production Possibilities Curve Why Have Countries Like Nepal Been So Slow to Specialize? Low population density Isolation Factors that my limit specialization in other countries Laws Customs

21. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 21 Factors That Shift The Economy’s Production Possibilities Curve Can we have too much specialization? What do you think? What are the costs of specialization?

22. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 2: Comparative Advantage: The Basis for ExchangeSlide 22 Comparative Advantage and International Trade Economic Naturalist If trade between nations is so beneficial, why are free-trade agreements so controversial?