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Comparative Advantage notes - Cherokee County Schools

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Comparative Advantage notes - Cherokee County Schools Powered By Docstoc
					Comparative Advantage:
One nation (individual/company) can produce a good at a lower opportunity cost than the other.
This comes into play when one individual (nation, company....) has the absolute advantage in
both.

                   Using numbers to calculate who has comparative advantage

       Output method: put the output of each product over the output of the other product for
the same person. This makes a fraction. Look at the opportunity cost. The person with the
lowest opportunity cost should produce the good that costs the least.


Example: Product per hour


                                                          Notice that Mike can produce more
                                                          Corn and Wheat. He has absolute
                                                          advantage in both. Does this mean he
                            Corn       Wheat              should produce both. NO!!! He should
            Mike             8              6             produce the one that he has
                                                          comparative advantage in and then
            John             2              4
                                                          trade for the other.




        Put the output of each product over the output of the other product. So it becomes
                                                Corn      Wheat
                                    Mike         6/8       8/6
                                     John        4/2       2/4




Reduce it and it becomes

                                                Now ¾ is less than 2 so Mike needs to
                                                produce corn.

                       Corn Wheat               ½ is less than 4/3 so John needs to produce
                Mike 3/4     4/3                Wheat.
                John    2    1/2




You will never have a situation where someone has comparative advantage in
both!!!!!
Input Method: divide the input required for each product into the input for the other product.
Then take the one with the lowest opportunity cost.

                                                       Apples to make one

                                                        Pie           Juice
                                                Jeff     5              3
                                                Judy    6               3




                                                       Based on this we can see that it takes Jeff less
                                                       apples to make a pie than Judy. It takes the same
                                                       amount to make juice. You must then figure out
                            Pie        Juice           who has absolute advantage. Reduce it:
             Jeff           5/3           3/5
            Judy            6/3           3/6           5/3 is less than 6/3 so Jeff should produce
                                                       pie. 3/6 is less than 3/5 so Judy should
                                                       produce Juice.


For each of the following problems identify who has absolute advantage, who has comparative
advantage and if it is input or output problem.


1. Days to Produce
                     Pen            Pencil
    Jean              5               4
    Mike              3               3


2. Number Produced

                    Books         Computers
    Eve               4               2
    Jake              5               5


3. Acres to Produce

                     Rice            Soy
   France             60              12
  Germany             20              12
4. From one ton of peanuts

                     Peanut    Peanut
                     Butter     Juice
 ABC Corp              50          20
  DEF Corp             60          70


5. Hours needed to

                               Clean
                   Mow Grass
                               Pool
    Aaron                  2       3
 Xiao Ling             4           4


6. Number per acre

                     Sheep     Goats
    USA                25          40
   Canada              12          6




Comparative and Absolute advantage can be looked at in combination with a production
possibility curve. A straight line curve is used to simplify the math.

                Nebraska                                             Florida
Wheat       0          20      40       60         Wheat   0       30          60      90
Pears       15         10      5        0          Pears   30      20          10      0


        This is on output problem. For every 20 Wheat Nebraska must give up 5 Pears.

                                                  Wheat         Pears
        Nebraska 20w = 5p                    so   5/20          20/5
        Florida 30w = 10p                         10/30         30/10
                Nebraska



Who has the absolute advantage in wheat?     ( Florida)

Who has the comparative advantage in wheat? (Nebraska)



People trade because both parties benefit from voluntary exchanges. This is true even if one
nation has both a comparative and absolute advantage.


Terms of Trade: the rate by which one unit of a good or service is traded for another unit of a
good or service such that they do better trading than they do on their own.

In this case if each produced the maximum of the good that they have the comparative advantage
they could then trade.

Nebraska produces 60 Wheat and Florida produces 30 Pears. They then trade with each other.

Reducing the earlier fraction we know that for Nebraska 4w = 1p. That means when they trade
they are giving up Wheat so they want to give up less than 4 wheat for 1p. Would they be
happy to give up 3w for 1p. Yes because it would take them 4 wheat to produce 1p.

For Florida 3w = 1p. How many wheat do they want from Nebraska for 1p? At least 3.

Would Florida take more than 3? Yes
That means between the two they will haggle so that the terms of trade are:
      1p = somewhere between 3 to 4 wheat

      By producing what they are good at and trading they are both doing better than they
would have before.

               Why Specialize?
       1. more efficient use of resources
       2. increased production without increase in resources
       3. increase division of labor


What happens to the production possibility curve when specialization occurs? (It is actually a
trading possibilities curve.)
Draw each PPC
       Who has absolute advantages?
      Who has comparative advantages?
      What are the Terms of Trade

         What has happened when they specialize?

         What happens to the production possibility curve when specialization occurs?

                 Scotland                                              USA
Cows     0       5          10          15        Cows         15        30        45       60
Sheep    30      20         10          0         Sheep        30        20        10       0




                                   Snehal                                               James
                     Bread         0         10    20     30    Bread         0          5 10     15
                     Apples        30        20    10     0     Apples        45        30 15     0




                            USA                                                           Japan
        Silver       0        30             60    90               Silver     0           5       10     15
        Gold      30          20             10    0                Gold      15          10          5   0

				
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