Microeconomics in Modules and Economics in Modules Third

Microeconomics in Modules and Economics in Modules Third Edition Krugman/Wells Module 4 Comparative Advantage and Trade

What You Will Learn 1 How trade leads to gains for an individual or an economy 2 The difference between absolute advantage and comparative advantage 3 How comparative advantage leads to gains from trade in the global marketplace 2 of 16

Gains from Trade • The key to a much better standard of living for everyone is trade. • The reason we have an economy is that there are gains from trade. • Gains from trade arise from specialization. 3 of 16

Production Possibilities for Two Countries

U. S. and Brazilian Opportunity Costs U. S. Opportunity Cost Brazilian Opportunity Cost One small jet ¾ of a large jet ⅓ of a large jet One large jet 4/3 small jets 5 of 16

Comparative Advantage and Gains from Trade

Comparative Advantage and Gains from Trade • Both countries are better off when each specializes in what it is good at and they trade. • Brazil should specialize in small jets. • The United States should specialize in large jets. 7 of 16

Comparative Advantage and Gains from Trade • A firm has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that firm than for others. • A firm has an absolute advantage in an activity if it can do it better than other firms. Having an absolute advantage is not the same thing as having a comparative advantage. 8 of 16

Comparative Advantage and Gains from Trade • Comparative advantage is the basis for trade. – Trade can be beneficial to both even if one has an absolute advantage in the production of both goods. • The PPF teaches two important lessons: – By agreeing to specialize and trade, both traders can be better off. – Everyone has a comparative advantage in something. 9 of 16

Economics in Action Rich Nation, Poor Nation • Most clothing is made overseas in countries that are much poorer than the United States. • The immediate reason for their poverty is that their economies are much less productive. • Even though these economies are much less productive, these countries hold a comparative advantage in clothing production. 10 of 16

Summary 1. A higher standard of living comes from specialization and trade. 2. Comparative advantage explains the source of gains from trade between individuals and countries. 3. Everyone has a comparative advantage in something. 4. Absolute advantage is the ability to produce a particular good or service better than anyone else. 11 of 16