1. Comparative advantageslide 1 The Gains from Trade Why do people specialize in the production of a few goods or services and then trade? Why don't people become self-sufficient instead, producing everything they need?

2. Comparative advantageslide 2 An Example Suppose there are two people, McPherson and Brown. Both can produce Tacos and Spaghetti, but they are not equally adept.

3. Comparative advantageslide 3 McPherson's Daily Production Possibilities tacos spaghetti10 5

4. Comparative advantageslide 4 McPherson has preferences that make him want to consume 4 tacos and 2 spaghetti. [Show his consumption point on the graph.]

5. Comparative advantageslide 5 Brown's Daily Production Possibilities tacos spaghetti10 5 12 Brown McPherson

6. Comparative advantageslide 6 Suppose that Brown consumes 5 spaghetti and 7 tacos. [Show his consumption point on the graph.]

7. Comparative advantageslide 7 Without specialization and trade here's where they are in production and consumption: ST Brown57 McPherson24 Total711

8. Comparative advantageslide 8 Absolute advantage: A person has an absolute advantage in the production of a good if he/she uses less inputs to produce a unit of the good. Notice that Brown has an "absolute advantage" in the production of both goods.

9. Comparative advantageslide 9 Comparative advantage: A person has a comparative advantage in the production of a good if that person can produce an extra unit of the good at lower opportunity cost.

10. Comparative advantageslide 10 Be sure you can answer these questions: 1) What's McPherson's cost of one more plate of spaghetti? 2) What's Brown's cost of one more plate of spaghetti? 3) Who has the "comparative advantage" in spaghetti production? Go to hidden slide

11. Comparative advantageslide 11 1) 1/2 2) 1 3) McPherson. [1/2 is less than 1.]

12. Comparative advantageslide 12 Now let McPherson specialize completely in the production of spaghetti, and Brown specialize completely in the production of tacos.

13. Comparative advantageslide 13 The table shows total production with specialization. More is produced of both goods. ST Brown012 McPherson100 Total1012

14. Comparative advantageslide 14 If Brown and McPherson can arrange to specialize and then trade, both can be better off. In this case the gains from specialization are 3 plates of spaghetti and 1 taco.

15. Comparative advantageslide 15 The Krugman Example The Krugman example of comparative advantage starts with input requirements instead of output limits. But the two are really equivalent.

16. Comparative advantageslide 16 The table shows labor requirements per vehicle. What’s the MC of a bus? 200 300600 100 AUTOBUS EAST WEST

17. Comparative advantageslide 17 The table shows labor requirements per vehicle. What’s the MC of a bus? 200 0.5 2 300600 100 AUTOBUS EAST WEST MC of BUS

18. Comparative advantageslide 18 Suppose each area had 3,000 hours total labor. Then EAST could produce 30 AUTOS, or 15 BUSES. Or any combination in between. And WEST could produce 5 AUTOS, or 10 BUSES. Or any combination in between.

19. Comparative advantageslide 19 30 15 5 WEST 10 EAST BUSES AUTOS MC of a BUS in the East is 2. MC of a BUS in the West is 0.5.