Mankiw Chapter 3
Absolute & Comparative Advantage
Absolute & Comparative Advantage
10 Principles:Trade can make everyone better off
It is easy to understand this when one country is worse than another country in production
It is harder to understand when a country is more efficient at producing the same goods and services
Absolute & Comparative Advantage
•How do we satisfy our wants and needs in a global economy?
–We can be economically self-sufficient.
–We can specialize and trade
with others, leading to
economic interdependence.
Specialization
Specialization is the cornerstone of trade.
Specialization- Producing what you’re best at
Or more formally: Production according to your comparative advantage.
Absolute advantage
•The comparison among producers of a good according to their productivity.
•Describes the productivity of one person, firm, or nation compared to that of another.
•The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.
Comparative Advantage
•Differences in the costs of production determine the following:
–Who should produce what?
–How much should be traded for each product?
Comparative Advantage
Input Vs. Output questions
Output questions
Opportunity cost of Good A = Production of Good B
Production of Good A
Input Questions
Opportunity cost of Good A = Production of Good A
Production of Good B
Comparative Advantage
•Two ways to measure differences in costs of production:
–The number of hours required to produce a unit of output . (inputs) oppty Cost of A= Prod A/Prod B
–The opportunity cost of sacrificing one good for another. (outputs)***historically AP FRQ’s
Opportunity Cost of A = Prod of B/Prod A
Comparative Advantage
•Compares producers of a good according to their opportunity cost, that is, what must be given up to obtain some item
•The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
*Ask yourselves which country has the comparative advantage in the production of each good, this is the good they should specialize in
Comparative Advantage in memes
Comparative Advantage in memes
Who has the comparative advantage?
Example & Process
Eddie & Dave’s Party
Eddie & Dave can each make the following combination of guitars and drums in 1 day
| Guitars | Drums |
Dave | 2 | 6 |
Eddie | 4 | 8 |
Absolute Advantage
Who Has the absolute advantage in Guitars?
Who Has the absolute advantage in Drums?
Comparative Advantage
Who has the comparative advantage in Guitars?
Explain.
Who has the comparative advantage in Drums?
Explain
Specialization
Who should produce Guitars?
Explain.
Who should produce Drums?
Explain.
Terms of Trade
In order for the terms of trade to be acceptable for both parties, they need to be able to produce outside of their original PPC (w/o trade ppc)
What would be an acceptable terms of trade for these two parties?
Is 1:1 a good deal for both parties?
Proposed terms of trade:
1 Guitar for 1 Drum kit?
Dave? (he produces Pizza)
YES!
Without trade to get a cake Dave had to give up 3 pizzas, with trade he would only have to give up 1 pizza for a cake
Eddie?
No!
Eddie’s trade off was ½ cake without trade to get 1 pizza , with trade he is asked to give up 1 cake to get a pizza
TERMS OF TRADE
What is an acceptable Terms of Trade?
CARS
TRACTORS
30
10
20
40
Atlantis
Xanadu
FRQ Review