Post on 13-Jan-2016
Absolute Advantage Comparative AdvantageEQ: How do we gain from trade?
What was the most importantdocument written in 1776?
He is my great, great, great, great, great grandfather on my mother’s side
What made The Wealth of Nations “THE” most important document written in 1776?
Adam Smith wrote about a pin factory.
What did they call the workers in thepin factory?
Just a bunch of pinheads.
When he first observed the factory,he noticed that each worker wasproducing his or her own pins. By the end of the day, the total production by each worker was 20 pins. He stated that each worker should specialize in the production stage rather than produce his or her own pins. Through specialization, the total output by the factory increased to 48,000 pins per day.(Page 11, Wealth of Nations)
One person draws the wire.
One person straightens the wire.
One person cuts the wire.
One person points the wire.
One person grinds the wire at the top to receive the head of the pin.
One person makes the head of the pin.
One person attaches the head to the pin.
I am going to prove that specializationworks. I am going to name a state andyou tell me what that state specializesin:
Idaho Potatoes
Florida Oranges
Texas Oil or cattle
Michigan Automobiles
Nevada Any illegal activity thatyou can think of
Absolute and Comparative Advantage
Betty types 120 w.p.m. with 0 errorsJim types 60 w.p.m. with 0 errors
Who should do the typing, Betty or Jim?
Betty. Why?
Betty can type ABSOLUTELY faster thanJim can. What type of advantage doesBetty have over Jim?
Absolute Advantage
Absolute Advantage--
One entity can produce somethingeither faster than or greater thananother entity.
I forgot to tell you--Betty is a lawyer.
A lawyer earns $60 an hour.
A secretary earns $6 an hour.
A 600-word document has to be typed, how long does it take eachperson to type this document?
How long does it take Betty to typethis document?
How long does it take Jim to typethis document?
Who should do the typing?
Jim
Comparative Advantage
One entity can produce somethingat a LOWER MARGINAL OPPORTUNITYPRODUCTION COST than anotherentity
Take absolute advantage and KICKIT OUT THE DOOR. The more important of the two is--
Comparative Advantage
Who has an absolute advantage in TVs? Fertilizer?
Japan U.S.
TV
Fertilizer
TV
Fertilizer
80
20
50
50
Input (IOU) or Output (OOO)?
• Input = other goes under• Output = other goes over
Who has the comparative advantage in the production of TV’s? Fertilizer?
Fertilizer TVs
Japan 20
1 ton Fertilizer = 4 TV’s
80
1 TV = ¼ ton Fertilizer
U.S. 50
1 ton Fertilizer = 1 TV
50
1 TV = 1 ton Fertilizer
What is Japan’s opportunity cost of 1
ton fertilizer?
What is Japan’s opportunity cost of 1
TV?
What is the U.S.’s cost of 1 ton
fertilizer?
What is the U.S.’s opportunity cost of 1
TV?
Terms of trade – 1 TV = 3/4 tons of fertilizer
Japan U.S.
TV
Fertilizer
TV
Fertilizer
80
20
50
5060
Consumption Possibilities Curve
62.5
Summary
• Please explain in your own words why trade makes us wealthier.