1.4 comparative advantage

Why do people trade?

1. Assume people didn’t trade. What things would you have to go without? 

Everything you don’t produce yourself!

(Clothes, car, cell phone, bananas, healthcare, etc.)

The Point: Everyone specializes in the production of some goods and services and trades for others.  

2.   What would life be like if people in cities couldn’t trade with people in other cities or people in states couldn’t trade with people in other states?

Limiting trade would reduce people’s choices and make people worse off. 

The Point: More access to trade means more choices and a higher standard of living. 

Absolute and Comparative Advantage

Per Unit Opportunity Cost Review

Per Unit Opportunity Cos t=  Opportunity Cost

Units Gained

Assume it costs you $50 to produce 5 t-shirts. What is your PER UNIT cost for each shirt? 

$10 per shirt

Now, take money out of the equation. Instead of producing 5 shirts you could have made 10 hats.

1. What is your PER UNIT OPPORTUNITY COST for each shirt in terms of hats given up? 

1 shirt costs 2 hats 

2. What is your PER UNIT OPPORTUNITY COST for each hat in terms of shirts given up? 

1 hat costs 1/2 shirt

review
Ronald McDonald can produce 20 pizzas or 200 burgers Papa John can produce 100 pizzas or 200 burgers

1. What is Ronald’s opportunity cost for one pizza in terms of burgers given up?

   1 pizza cost 10 burgers

2. What is Ronald’s opportunity cost for one burger in terms of pizza given up?

   1 burger costs 1/10 pizza

3. What is Papa John’s opportunity cost for one pizza in terms of burgers given up?

   1 pizza costs 2 burgers

4. What is Papa John’s opportunity cost for one burger in terms of pizza given up?

1 burger costs 1/2 pizza
Ronald has a COMPARATIVE ADVANTAGE in the production of burgers.

Papa John's has a COMPARATIVE ADVANTAGE in the production of pizza. 

Terms of Trade

Both countries can benefit from trade if they each have relatively lower opportunity costs. 

Terms of Trade- The agreed upon conditions that would benefit both countries.

Ex: Trade 1 ton of wheat for 1.5 tons of sugar 

Absolute Advantage – When one party (a person, company, or country) can produce more of a good or service using the same amount of resources as another.

• Example: If the U.S. can produce 100 cars in a day while Japan can only produce 80 cars with the same resources, the U.S. has an absolute advantage in car production.

Comparative Advantage – When one party can produce a good at a lower opportunity cost than another, even if they don’t have an absolute advantage.

• Example: Suppose the U.S. can produce both cars and computers but gives up fewer computers to make one car than Japan does. If Japan gives up more computers to make cars, the U.S. has a comparative advantage in car production, while Japan might have a comparative advantage in computer production.