Notes on Comparative Advantage and PPF

Comparative Advantage

• Opportunity Cost

  • Defined as the value of the next best alternative that must be foregone in order to undertake an activity.
  • Example: If Toni can collect 10 coconuts or catch 5 fish in a day, the opportunity cost of collecting one coconut is 0.5 fish.

• Production Possibility Frontier (PPF)

  • Illustrates combinations of two goods that a person or entity can produce with current technology.
  • Shows scarcity: Downward slope indicates that to increase production of one good, one must decrease production of another good.
  • Bundles outside the PPF are unattainable given current resources.

• Principle of Increasing Opportunity Cost

  • As more of a good is produced, the opportunity cost of producing additional units increases.
  • This principle is visually represented by the PPF being bowed outward.
  • The reasoning: Initially, resources with lower opportunity costs are used first, followed by those with higher opportunity costs.

• Opportunity Cost Example

  • If Lisa can produce 6 fish and has the option to give up producing fish for coconuts, the slope of her PPC will indicate her opportunity cost for switching production.

Factors Affecting the PPC

• Economic Growth

  • Caused by increases in productive resources, improvements in knowledge or technology.

• Implications of Change

  • Introduction of better tools (e.g., a fishing rod) can shift the PPF outward, indicating increased productive capacity.

Usefulness of PPF and Comparative Advantage

• Understanding Comparative Advantage

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

• Example of Comparative Advantage

  • Suppose Gilligan can produce coconuts and Mary Ann can produce both coconuts and fish. The analysis of their PPCs can reveal who has a comparative advantage in each good.

• Specialization and Trade Principle

  • The best outcomes arise when individuals or countries specialize in activities for which they have the lowest opportunity costs.

Gains from Trade

• Trade Dynamics

  • Trade arises from comparative advantages; countries can benefit from specializing and exchanging goods.
  • While free trade increases total value, it may not benefit every individual equally.

• International Trade and the iPhone Example

  • Apple, based in the U.S., assembles iPhones in China, highlighting the effects of globalization:
  • Winners: Consumers and technology professionals.
  • Losers: U.S. manufacturing workers due to offshoring.

Shifting Views on International Trade

• Impact of “China Shock”
  • Recent studies indicate that areas in the U.S. exposed to competition from China saw wage stagnation and higher unemployment rates following China's economic ascent in the late 1990s.
  • Important for understanding labor market adjustments in response to significant trade changes.