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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.