Specialization and Comparative and Absolute Advantage Adam Smith

Specialization and Comparative and Absolute Advantage

Adam Smith quote: • • • It is the maxim of every prudent master of a family never to attempt to make at home what it will cost him more to make than to buy. The taylor does not attempt to make his own shoe. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbours and to purchase with a part of its produce whatever else they have occasion for. What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? -Smith, Adam An Inquiry into the Nature and Causes of the Wealth of Nations, bk. 4, ch. 2.

Consider this: • You are a lawyer but also a good builder. You want to add a room onto your house and you know that you could probably do it better than any contractor you hire. Is it wise for you to build it yourself?

Quick review: • What is opportunity cost? • How do we determine opportunity cost?

Specialization • Concentration of production on a limited number of activities • People and nations benefit from specializing in one area • Results in more efficient production

Absolute Advantage • When a person or nation can produce more of a given object using the given resources • 2 countries have the same amount of timber- one produces more wooden goods

Comparative Advantage • A country has a comparative advantage in the product that it can produce most efficiently given all it could choose to produce • Based on opportunity cost- not absolute cost

Comparative Advantage • If Mexico’s opportunity cost for producing coffee is lower than the US’s, then it has a comparative advantage • This can be true even if the US has an absolute advantage in the area

Beneficial Scenario • Mexico • Brazil Broccoli 0 20 24 40 60 Coffee 15 10 9 Broccoli 0 Coffee 30 20 19 10 0 5 0 30 33 60 90 • Who has an absolute advantage in producing coffee? In broccoli? • What are Mexico’s opportunity costs? Brazil’s? • Who has a comparative advantage in coffee? In broccoli?

Beneficial Scenario • Mexico • Brazil Broccoli 0 20 24 40 60 Coffee 15 10 9 Broccoli 0 Coffee 30 20 19 10 0 5 0 30 33 60 90 • What should each country produce? • Given the opportunity cost of the two countries’ areas of specialization, what would be a beneficial trade amount?

Beneficial Scenario • Mexico • Brazil Broccoli 0 20 24 40 60 Coffee 15 10 9 Broccoli 0 Coffee 30 20 19 10 0 5 0 30 33 60 90 • Now let’s assume that the middle scenario would be picked if each country were producing both on their own. Can that amount be outdone through specialization and trade? Assume both are producing only the good they have a comparative advantage in.

Homework • Lesson 1, Activity 2 - pages 9 -14