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					                        Comparative advantage:
     How come that Canada, US, France, China all have land people capital natural resources
      but all of the countries produce such different things.
    Principle that applies equally to explaining behavior of people and nations but something
      that we all believe to be true for individuals we find extremely difficult to believe about
      other units
    “name one economic theory that is both true and nontrivial””Comparative advantage”
    Samuelson: “Imagine that the best lawyer is also the best secretary”
    David Ricardo who explained it clearly in his 1817 book On the Principles of Political
      Economy and Taxation in an example involving England and Portugal
Motivation:
   - Who can produce more t-shirts in an hour (who is more productive) American or Chinese
      worker?
   - Where do you get a higher yield of wheat per acre in Kansas or Indiana?
   - Who can a better job greeting people in Walmart Jay Leno or whoever is doing it right
      now?
   - Wages? Wages are a result, not a reason.
          o Is summer caused by high temperature? It is the amount of sunlight
          o Why do you use more gasoline from Denver to Laramie than otherwise? Because
              your car burns more gasoline? No because Laramie is at a higher altitude than
              Denver.
Lesson Plan:
   1. US and the world economy
          a. Two waves of globalization
          b. Trade/GDP for world countries
          c. Goods traded, major trading partners
   2. Comparative advantage
          a. Examples of people and countries specializing
          b. Bill and John’s example in table form (example #1)
          c. PPF representation of John’s and Bill’s production
                    i. Define PPF
                   ii. Points inside/on/ouside
          d. Why is PPF downward sloping?
                    i. Scarce time
                   ii. Time has alternative uses
                  iii. Bill and John face tradeoffs when allocating their time
                  iv. Tradeoffs are characterized by opportunity cost
          e. What is Johns opportunity cost of changing tires? It is the amount of pages that he
              does not type per tire
                    i. Calculate opportunity costs
                   ii. Show that the opportunity cost of the good on the horizontal axis is the
                       absolute value of the slope of the PPF
          f. Can they gain from trade?
                    i. Show before trade when Bill and John both produce tires
                   ii. Decide who would produce what when specializing
                  iii. Show after trade
           g. Show the after trade point on the PPF
Simple example#1
   - Two people, two tasks, people differ in productivity per hour
                                       John                            Bill
       Typing pages                    10                              20
       Changing tires                  2                               2
   - If they spend their time equally on both tasks they get
                                       John               Bill                        Total
       Typing pages                    .5 hour x 10 = 5 .5 hour x 20 = 10             15
       Changing tires                  .5 hour x 2 = 1    .5 hour x 2 = 1             2
   - What if they specialize?
           o Who should be doing what?
           o Intuitively: Bill should type
           o What is the opportunity cost of changing one tire?
                    John 5 pages (10/2), Bill 10 pages (20/2).
                    The action of changing a tire is costlier to Bill
                    So John should be changing tires and Bill should be typing
           o What is the opportunity cost of typing?
                    For every person
                           OPP COST OF TYPING = 1/OPP COST OF CHANGING TIRES
   - A possible split if they specialize:
                        John                      Bill                      Total
                        Produces Consumes Produces Consumes
       Typing pages 0               8             20          12            20
       Changing tires 2             1             0           1             2
       Gain                         8-5=3pages                12-10=2pages
   - both gain from trade
   - We say that Bill has absolute advantage in typing and he also has comparative advantage
       in typing
   - Two ways to get tires for bill:
           o Make it: it takes 30min
           o Trade for it: make 20 (1 hour) give up 8 (8/20=40% of an hour or 24 min)
   - Who will have a higher wage?
           o Bill because is more productive
   - Graphically let’s show the tradeoff between everything that is possible to produce (PPF)

SHOW: a point on, a point inside, and a point outside.
                                                         Typing pages
          Typing pages




                         20                  Bill                                      John


                                                                 10
                                2 Changing tires                                2    Changing tires
SHOW: negative slope because it represents a tradeoff, slope is equal to the opportunity cost of
changing tires
                                                                              Bill’s production point:
20
                    Slope=opp. Cost                                      20   0,20
                            of tires




                                                          Typing pages
                                                                         12
                                                                         10           Bill’s consumption
                                                                                      point: 1,12


                  2    Changing tires
                                                                         1      2 Changing tires
SHOW: point before and after
SHOW trade and terms of trade. Bill gives up 8 pages to get 1 tire, he traded his pages for 1/8 of
a tire. When he produced he gave up pages for 1/10 of a tire. Another way to see gains from
trade.
Example with two states #2 (did not do in Fall 2008)
   - Two states, two crops, production from an acre
                           Kansas                        Indiana
       Wheat               60                            90
       Corn                30                            90
   - Since Indiana is more productive in both it has an absolute advantage in both
   - But who has comparative advantage
           o Opportunity cost of corn in Kansas is 60/30=2 bushels of wheat
           o Opportunity cost of wheat in Indiana is 100/100=1 bushel of wheat
           o Indiana has a lower opportunity cost of corn
   - Can they still gain from specialization?
   - Assume the states are of the same size, 1 acre. Before (say they use 1/3 on wheat and 2/3
       on wheat)
                           Kansas                        Indiana
       Wheat               20                            30
       Corn                10                            60
   - When they specialize they produce and possibly consume
                      Kansas                          Indiana
                      Produce       Consume           Produce          Consume
       Wheat          60            25                0                35
       Corn           0             20                90               70
       Gain                         5wheat,10corn                      5wheat, 10corn
PPF is a tool to show tradeoffs
   - A point on, inside, outside
   - Opportunity cost is the slope

Important point: Comparative advantage determines who produces which product
Important point: Absolute advantage determines which country has higher wage
Important point: Trade is similar to production
Example from chapter 6
Assume:
   i.      every country has 1000 hours and every country splits it 750/250 on CellPhones and
           DigitalMusicPlayers respectively.
   ii.     Terms of trade are 1. How is it possible? Assume that the prices are $200 each.
Analyze autarky and then trade
   1. Setup:
           a. Japan: opportunity cost of cell phones is: ()/()
           b. Food for thought: does time in itself has value? No, it is only as valuable as your
              next alternative.
   2. Autarky (table 6.3): when every country produces and consumes what it produces
       Japan:
              750x12=9000 cell phones
              250x6=1500 iPods
       US
              750x2=1500 cells
          250x4=1000 iPods
3. With trade: who has comparative advantage in production of which goods
      a. Japan has lower opportunity cost of producing cell phones. Japan produces only
          cellphones. It makes 1000hours x 12=12000
      b. US has lower opportunity cost of producing iPods. US produces iPods. It makes
          1000hours x 4=4000
      c. Assume countries trade 1500. (this example is worked out to make sure that the
          gain is only in one of the goods for each country)
      d. Additional question: Would this example work if the countries traded 2000
          goods? What would be the gain from trade? Japan: 1000 cellphones, 500ipods;
          US: 1000 cellphones, 1000iPods.

				
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posted:11/27/2011
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