Comparative Advantage and Production Possibility Frontier

Comparative Advantage

Opportunity Cost

• The opportunity cost of an action is the value of the next best alternative that must be foregone to undertake the activity.

Production Possibility Frontier (PPF)

• The PPF illustrates the combinations of two goods that can be produced with current technology by a person, family, city, state, or country.
• Example: Toni on an island can either collect 10 coconuts or catch 5 fish in one day.

Opportunity Cost of Production

• To determine the opportunity cost, analyze the Production Possibility Curve (PPC).
• Example question: What is Lisa’s opportunity cost of producing 1 pound of fish? (Specific calculations based on her PPC would be required.)

The Principle of Increasing Opportunity Cost

• As production of a good increases, the opportunity cost generally increases.
  • This is represented by a bowed outward PPF.
  • Initial resources with the lowest opportunity cost are employed first, then resources with higher opportunity costs are utilized.
  • Also known as the low-hanging fruit principle.

Examples of Opportunity Cost in Agricultural vs. Capital Goods

• If bundles (A, C) = (100,0) and (A,C) = (50,40) are on the PPC, the maximum production of capital goods when all resources are devoted to it cannot be precisely determined without additional data.
• Answers could denote: A. More than 80, B. Exactly 80, C. Fewer than 80, or D. Not enough information.

Factors Affecting the PPF

• Economic Growth
  • Results from increases in productive resources or improvements in knowledge/technology.
• Example: If Gilligan receives a fishing rod, this may expand his PPF for coconuts and fish.

Usefulness of PPF

• Demonstrates scarcity: Downward sloping illustrates trade-offs where increasing one good means reducing another.
• Areas outside the PPF are unattainable with current resources.
• Shows opportunity cost: The slope indicates how much of one good must be given up to obtain another.

Comparative Advantage

• Definition: A person has a comparative advantage in producing a good if their opportunity cost of producing that good is lower than for anyone else.
• Absolute Advantage: A person has an absolute advantage if they can produce more of a good using the same resources than anyone else.

Comparative Advantage Examples

• Daily PPC analysis between Gilligan and Mary Ann reveals comparative advantage in production of coconuts and fish based on opportunity costs.
  • For specific tasks (e.g., Amy and David making pizzas and salads), calculations will show comparative advantages based on time taken.

Principle of Comparative Advantage

• Individuals or countries benefit the most when they specialize in activities with the lowest opportunity cost.

Gains from Trade

• Trade allows for mutual benefits through specialization.
  • Example of production levels for cloth and computers showing how two individuals or nations can both benefit from trade.

Comparative Advantage and International Trade

• Nations, like individuals, can increase value of goods/services through specialization and exchange.
• Free trade has benefits, but not all individuals may be better off, as some may be adversely affected.

Case Study: International Trade and the iPhone

• Apple's iPhone assembly occurring in China versus the U.S. presents winners (consumers, designers, engineers) and losers (U.S. manufacturing workers).

Shifting Economic Views on International Trade

• Recent studies show the impact of globalization (e.g., the "China shock") on labor markets in the U.S.
  • Evidence suggests low wages and high unemployment in regions exposed to competition from China, lasting over a decade post-shock.
  • Suggested further reading: "The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade."