CH 5 SPECIALIZATION AND COMPARATIVE ADVANTAGE DO WHAT

CH. 5 SPECIALIZATION AND COMPARATIVE ADVANTAGE “DO WHAT YOU DO BEST AND TRADE FOR THE REST”

Specialization and Comparative Advantage • Basic Principle-specialization and trade increase the productivity of a nation’s resources; it pays for a country to specialize and exchange even if that person or nation is more productive than potential trading partners in all economic activities.

Specialization and Comparative Advantage • Basic Principle • Comparative Costs-specialization should take place if there are relative cost differences in the production of different items (if someone else can do something cheaper they should and then trade). • A nation (or business or person) has a comparative advantage if it can produce a product at a lower opportunity cost than its partner

Specialization and Comparative Advantage • Basic Principle • Comparative Costs • Terms of Trade-the rate of exchange of two products; determined by relative opportunity costs

Specialization and Comparative Advantage • Basic Principle • Comparative Costs • Terms of Trade • Gains from Specialization & Trade-can improve overall output even when one country can do it all better; has same effect as an increase in resources

I am going to prove that specialization works. I am going to name a state and you tell me what that state specializes in: Idaho Potatoes Florida Oranges Texas Michigan Nevada Oil or cattle Automobiles Any illegal activity that you can think of

Absolute and Comparative Advantage Betty types 120 w. p. m. with 0 errors Jim types 60 w. p. m. with 0 errors Who should do the typing, Betty or Jim? Betty. Why? Betty can type ABSOLUTELY faster than Jim can. What type of advantage does Betty have over Jim? Absolute Advantage

I forgot to tell you--Betty is a lawyer. A lawyer earns $60 an hour. A secretary earns $6 an hour. Betty is the lawyer. According to the information given, that makes Jim--A secretary. A 600 -word document has to be typed, how long does it take each person to type this document?

How long does it take Betty to type this document? 5 minutes 600 divided by 120 = 5 How long does it take Jim to type this document? 10 minutes 600 divided by 60 = 10

How much would it cost each one to type this 600 -word document? Betty $5 Betty receives $60 an hour or $1 per minute. It takes her 5 minutes to type the document. Jim $1 Jim receives $6 an hour or $1 for every 10 minutes. It takes him 5 minutes to type the document.

We know that it takes Betty 5 minutes to type the document, and it takes Jim 10 minutes to type the document. We also know that it costs Betty $5 to type the document, and it costs Jim $1 to type the document. According to this information, who should do the typing? Jim

Why should Jim do the typing? Because he has a-- Comparative Advantage One entity can produce something at a LOWER MARGINAL OPPORTUNITY PRODUCTION COST than another entity

Five minutes ago you told me that Betty should do the typing; now you are telling me that Jim should do the typing. Why? Because Jim has the comparative advantage. Which is more important in economics-absolute or comparative advantage? Comparative Advantage

Take absolute advantage and KICK it out the window. The more important of the two is-- Comparative Advantage

Man-hours required U. S. Canada Maple Syrup 5 8 Copper Wire 6 7 Which country has the absolute advantage in the production of Maple Syrup? In Copper Wire?

Man-hours required U. S. Canada Maple Syrup 5 8 Copper Wire 6 7 Kick it. I out What did tell youthe to dowindow! with Absolute Advantage?

Man-hours required U. S. Canada Maple Syrup 5 8 Copper Wire 6 7 More importantly, which country has the Comparative Advantage in Maple Syrup? In Copper Wire? And Why?

Man-hours required U. S. 1 Maple Syrup 2 Canada 1 Copper Wire 2 U. S. 2 x 5 = 10 +6 11 U. S. saves one-man hour Canada saves one-man hours Canada 8 2+ x 7 = 14 15

Production-Possibilities Curve/Frontier

Ireland Crystal Rum A 1 million 0 B 700, 000 30, 000 C 0 100, 000 Puerto Rico Crystal A 80, 000 B 40, 000 C 0 Rum 0 40, 000 80, 000

Crystal 1 million Crystal A B 700, 000 80, 000 A B 40, 000 C 0 30, 000 Ireland 100, 000 Rum Crystal Rum A 1 million 0 B 700, 000 30, 000 C 0 100, 000 0 40, 000 C 80, 000 Rum Puerto Rico Crystal A 80, 000 B 40, 000 C 0 Rum 0 40, 000 80, 000

Crystal 1 million Crystal A B 700, 000 80, 000 40, 000 A B C 0 30, 000 Ireland 100, 000 Rum 0 40, 000 C 80, 000 Puerto Rico Rum Which country has the absolute advantage in the production of Crystal? In the production of Rum? What did I tell you to do with absolute advantages? KICK IT OUT THE WINDOW!!!

Crystal 1 million 700, 000 Crystal A B 80, 000 A 40, 000 0 30, 000 Ireland C 100, 000 Rum 0 B 40, 000 C 80, 000 Rum Puerto Rico Which country has the comparative advantage in Crystal? In Rum?

Crystal 1 million 700, 000 Crystal A B 80, 000 A 40, 000 0 30, 000 Ireland C 100, 000 Rum 0 B 40, 000 C 80, 000 Rum Puerto Rico There are___steps 5 in figuring out which country has the comparative advantage.

Crystal 1 mil. A Crystal B 700, 000 80, 000 A 40, 000 0 30, 000 C 100, 000 Rum 0 B 40, 000 C 80, 000 Rum Ireland Puerto Rico 1. Know the definition of comparative advantage One entity can produce something at a LOWER MARGINAL OPPORTUNITY COST than another entity. 2. Set up a table: Ireland 1 Rum = __Crystal 1 Crystal = __ Rum 3. Go to the Xtremes (X and Y Games) Puerto Rico 1 Rum = __Crystal 1 Crystal = __Rum

Crystal 1 mil. A Crystal B 700, 000 80, 000 A 40, 000 0 1. 2. 3. 4. 5. 30, 000 C 100, 000 Rum 0 B 40, 000 C 80, 000 Rum Ireland Puerto Rico Know the definition of comparative advantage Ireland Puerto Rico Set up a table: 1 Rum = 10 __Crystal 1 Rum = __Crystal 1 1 Crystal = ____ 1/10 Rum 1 Crystal = __Rum 1 Go to the Xtremes (X and Y Games) Fill in the blanks (starting with Puerto Rico first) Circles and Arrows

Crystal 1 million 700, 000 A Crystal B 80, 000 A 40, 000 0 30, 000 Ireland C 100, 000 Rum 0 B 40, 000 C 80, 000 Rum Puerto Rico We decided that Ireland should produce ALL the crystal and Puerto Rico should produce ALL the rum. How much crystal should Ireland produce? 1 million cases How much rum should Puerto Rico produce? 80, 000 barrels Should Ireland just hold onto its cases of crystal and Puerto Rico just hold onto its barrels of rum? NO! What should each country do after specialization? Trade

Crystal 1 million 700, 000 A Crystal B 80, 000 A B 40, 000 0 Produces 30, 000 C 100, 000 Rum Ireland Trades Consumes after specialization and Trade 0 40, 000 C 80, 000 Rum Puerto Rico Consumes before Trade (Point B) Gain from Trade IRELAND C R 1 million -175, 000 0 +35, 000 825, 000 35, 000 700, 000 30, 000 175, 000 40, 000 +125, 000 + 5, 000 PUERTO RICO C R 0 80, 000 +175, 000 -35, 000 +135, 000 +5, 000

Crystal 1 million A Crystal D 825, 000 700, 000 D 175, 000 80, 000 A B 40, 000 B 35, 000 0 Produces 30, 000 C 100, 000 Rum Ireland Trades Consumes after specialization and Trade IRELAND C R 1 million -175, 000 0 +35, 000 825, 000 35, 000 Plot this column 45, 000 C 0 80, 000 Rum Puerto Rico Consumes before Trade (Point B) 700, 000 30, 000 40, 000 Gain from Trade +125, 000 + 5, 000 PUERTO RICO C R 0 80, 000 +175, 000 -35, 000 175, 000 40, 000 +135, 000 +5, 000

Crystal 1 million A Crystal D 825, 000 700, 000 80, 000 A B 40, 000 35, 000 0 D 175, 000 30, 000 Ireland C 100, 000 Rum B 45, 000 C 0 40, 000 80, 000 Rum Puerto Rico Which country is obviously better off through this specialization and trade--Ireland or Puerto Rico? Both Countries are!!! Both countries are now outside their own production capabilities. Through specialization and trade all parties are better off.

Wheat 100 Country B Country A Z 100 Y 300 Cloth 2. Assume that Countries A and B have equal amounts of resources and identical technologies. Country A can produce 100 bushels of wheat or 100 yards of cloth or any combination, as shown by the line XZ in the figure above. Country B can produce 100 bushels of wheat or 300 yards of cloth or any combination, as shown by the line XY in the figure above.

Wheat 100 Country B Country A Z 100 Y 300 Cloth (a) Which country has an absolute advantage in the production of wheat and which has an absolute advantage in the production of cloth? Explain how you determined your answer. Neither country or both countries has the absolute advantage in the production of wheat. Both countries can produce 100 bushels of wheat. Country B has the absolute advantage in the production of cloth. It can produce absolutely more cloth (300) than Country A (100). Absolute advantage is which entity can produce absolutely more than another entity.

Wheat (b) Which country has a comparative advantage in the production of wheat and which country has the comparative advantage in the production of cloth? Explain how you determined your answer. 100 Country B Country A Z 100 Y 300 Cloth A B 1 C 3 1 W = __C 1 C = __W 1 1 C = 1/3 __W Country A has the comparative advantage in wheat and Country B has the comparative advantage in cloth because they can both produce those items at a lower marginal opportunity production cost.

Wheat C) With specialization and trade, which country will import wheat? Explain why. 100 Country B Country A Z 100 A 1 C 1 W = __ 1 C = __W 1 Y 300 Cloth B 3 1 W = __C 1 C = 1/3 __W Country B should import the wheat because Country A has a comparative advantage in wheat and should produce all the wheat.