Absolute v Comparative Advantage Two countries Bolivia and

Absolute v. Comparative Advantage Two countries: Bolivia and Canada Essential Question: What goods and services should an economy produce?

Goods ¡ Two goods: Chairs and Sweaters ¡ One resource: hours of labor Essential Question: What goods and services should an economy produce?

Absolute advantage: The ability to produce something using fewer resources than other producers use CANADA BOLIVIA HOURS OF LABOR NEEDED TO PRODUCE 1 1 Sweater 1 Chair ¡ ¡ 5 hrs 8 hrs 20 hrs 24 hrs Canada has absolute advantage in producing sweaters Canada has absolute advantage in producing chairs Essential Question: What goods and services should an economy produce?

Comparative Advantage The ability to produce something at a lower opportunity cost than other producers face Essential Question: What goods and services should an economy produce?

Determining comparative advantage ¡ How much does it cost to produce 1 chair? l l l The cost will be in terms of sweaters that could have been produced in the same amount of time as 1 chair For Bolivia, how many sweaters could have been produced in 24 hours? For Canada, how many sweaters could have been produced in 20 hours? Essential Question: What goods and services should an economy produce?

Determining comparative advantage CANADA BOLIVIA Cost of producing 1 chair in terms of sweaters 1 Chair ¡ 4 sweaters 3 sweaters Bolivia has comparative advantage in producing chairs because it would mean having to give up fewer sweaters Essential Question: What goods and services should an economy produce?

Determining comparative advantage ¡ How much does it cost to produce 1 sweater? l The cost will be in terms of (fraction of) a chair that could have been produced in the same amount of time as 1 sweater Essential Question: What goods and services should an economy produce?

Opportunity cost of 1 sweater CANADA BOLIVIA Cost of producing 1 sweater in terms of chairs 1 Sweater ¡ ¼ chair 1/3 chair Canada has comparative advantage in producing sweaters because it would mean having to give up fewer chairs Essential Question: What goods and services should an economy produce?

Law of comparative advantage ¡ The individual, firm, region, or country with the lowest opportunity cost of producing a particular good should specialize in producing that good. Essential Question: What goods and services should an economy produce?

Absolute and Comparative Advantage ¡ ¡ The comparative advantage allows people, firms, or nations to specialize and trade Specialization: focusing production more heavily on a good for which you have a comparative advantage, with the expectation of trading for other goods for which you do not have a comparative advantage Essential Question: What goods and services should an economy produce?

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, heath care, etc) The Point: Everyone specializes in the production of goods and services and trades it to others 2. What would life be like if cities couldn’t trade with cities or states couldn’t trade with 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. Essential Question: What goods and services should an economy produce? 11

Per Unit Opportunity Cost = 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 our 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 a half of a shirt Essential Question: What goods and services should an economy produce? 12

Per Unit Opportunity Cost Ronald Mc. Donald 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 ADVANTGE in the production of burgers Papa John has a COMPARATIVE ADVANTAGE in the production of pizza Essential Question: What goods and services should an economy produce? 13

Absolute and Comparative Advantage Absolute Advantage • The producer that can produce the most output OR requires the least amount of inputs (resources) • Ex: Papa John has an absolute advantage in pizzas because he can produce 100 and Ronald can only make 20. Comparative Advantage • The producer with the lowest opportunity cost. • Ex: Ronald has a comparative advantage in burgers because he has a lowest PER UNIT opportunity cost. Countries should trade if they have a relatively lower opportunity cost. They should specialize in the good that is “cheaper” for them to produce. Essential Question: What goods and services should an economy produce? 14

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AP Microeconomics Exam 2003, #3 16

AP Question Mary Jane is a lawyer who can earn $150 per hour in her law practice. She is also an excellent carpenter who can build cabinets three times faster than the best carpenter, who earns $20 per hour. Which of the following economic statements are correct? (A) M. J. has a comparative advantage in law so she should specialize in law and hire the carpenter. (B) M. J. has an absolute advantage and comparative advantage in both law and carpentry, so she should make her own cabinets while continuing to practice law (C) M. J. is 3 times faster than any carpenter, so she should give up her law practice and be a carpenter (D) When carpenters work for lawyers they should charge $150 per hour instead of $20 (E) Because M. J. is an excellent carpenter, she should only have to pay one third as much, or $6. 67 per hour. #42 2001 AP Macro Exam

American labor is a Financier who can earn $150 Billion per year in its business finance practice. They are also excellent automakers who can build Cars three times faster than the Mexican car-makers, who earns $20 Billion per year. Mexico may also do business finance, but can only earn $15 Billion to do so. Which of the following economic statements are correct? (A) USA has a comparative advantage in finance so she should specialize in finance and hire the Mexican carmakers. (B) USA has an absolute advantage in both finance and carmaking, so she should make her own cars while continuing to practice finance (C) USA is 3 times faster than any car-makers, so she should give up her finance practice and be a car-makers (D) When car-makers work for Financiers they should earn $150 Billion per year instead of $20 (E) Because USA is an excellent car-makers, Mexico should only get to earn one third as much, or $6. 67 Billion.

The Circular Flow Model 19

The Circular Flow Model The Product Market • The “place” where goods and services produced by businesses are sold to households. The Resource (Factor) Market • The “place” where resources (land, labor, capital, and ent. ) are sold to businesses. 20

DEMAND $ $ $ s o C ts $ $ $ c r u e R Businesses G $$ $ Re $$ $ es so oo Se ds rv an ic d es Re (F so SUPPLY In c om e Pr ac u od to rc uc rs es tio of n) nd a s s ce d i o v o er G S ve n ue SUPPLY Resource Market $$ Product Market $ $ $$ $ Individua g n i $ $ $ d n e p S 21 DEMAND