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Chapter 2 - Comparative advantage. Chapter 2 goes beyond individual decision making to consider trade among both individuals and countries. An important reason for trade is the Principle of Comparative Advantage: by specializing in the production of particular goods and services, people and countries enhance their productivity and raise standards of living.
able Definitions: Combination – – Unattainable point Attainable point • • • Inefficient point Efficient point Scarcity Principle – Give up one good to get another Coffee Beans (kg/day) • 16 B Inefficient Combination C D 12 Nuts (kg/day) 214 Susan's Production Possibilities Two goods: coffee beans and nuts – • Work hours per day hour of labor = kg of coffee beans OR = kg of nuts – Graph shows options • Negative slope A Coffee Beans (kg/day) • B C D Nuts (kg/day) 215 Susan's Opportunity Cost Marginal cost: – coffee Marginal benefit: nuts • • Loss in coffee • Opportunity cost of nut is coffee Marginal cost: – nuts Marginal benefit: 16 coffee • • A Coffee Beans (kg/day) Gain in nuts B C D Loss in nuts Gain in coffee (kg/day) Opportunity cost of coffee is ẵ nut Nuts 216 Tom's Production Possibilities – • Work hours per day Productivity determines the slope of the PPC hour of labor = kg of nuts OR – • – – • • Opportunity cost Marginal cost: – coffee Marginal benefit: nuts Tom's opportunity cost of coffee is nuts His opportunity cost of nut is ½ coffee A B Coffee Beans (kg/day) = kg of coffee beans C D Nuts (kg/day) 217 Tom, Meet Susan • • PPCs show comparative advantage • Sue's curve is steeper, better for coffee • Tom's curve is flatter, better for nuts Comparative advantage is a comparison To get coffee • Sue gives up ẵ nuts Tom gives up nuts Coffee Beans (kg/day) • Susan’s PPC Tom’s PPC Nuts 2(kg/day) 218 Gains from Specialization and Trade • Without trade, each person can consume along his production possibilities curve – • What you produce determines what you consume With trade, each person's consumption can be greater than production – – Produce according to comparative advantage Trade to get what you want 219 Coffee Beans (kg/day) Gains from Specialization and Trade Susan and Tom exchange 12 nuts, 12 coffee • – • Nuts (kg/day) – Preferred diet is half nuts, half coffee No trade: kg of coffee bean and kg of nuts • Total output is 32 kg Specialization gives each person 12 kg of each good 48 total kilograms 220 Gains from Specialization and TradeBenefits increase when • Sue's PPC Coffee Beans (kg/day) 24 Trade benefits 12 With trade Tom's PPC No trade 12 24 • Nuts (kg/day) • differences in opportunity cost increase – Sue's opportunity cost of one kilogram of nuts increases to coffee – Tom's opportunity cost of one kilogram of coffee increases to nuts No trade: 3.4 nuts and 3.4 coffee each With trade: 12 nuts and 12 coffee each 221 Production Possibilities for an Economy • Two goods: coffee beans and nuts Multiple people • Different opportunity costs 10 A 90 • • B Intercepts show maximum production of one good Some resources better at coffee, some better at nuts C Coffee (1000s of kg/day) • D E 15 30 Nuts (1000s of kg/day) 222 The Principle of Increasing Opportunity Cost Maximum coffee: 100,000 kg / day – – Give up 5,000 kg coffee beans, get 20,000 kg of nuts Give up another 5,000 kilograms of coffee beans, get 10,000 additional kilograms of nuts 100 95 A B C Coffee (1000s of kg/day) • D E 20 20 Nuts (1000s of kg/day) 80 77 223 Outsourcing • • Service work performed overseas by low wage workers has been termed outsourcing – Medical transcription ▪ Medical tourism – Customer call centers ▪ Technical writing Limits to outsourcing – – – – • Quality control Physical presence (haircuts) Complex communications Understand nuance Greatest security for workers is the ability to adapt quickly to changing circumstances 230 Comparative Advantage Comparative Advantage Increasing Opportunity Cost Production Possibilities Curve Individual Specialization and Gains from Trade Outsourcing Shift PPC Economy 231 ... kg coffee beans, get 20 ,000 kg of nuts Give up another 5,000 kilograms of coffee beans, get 10,000 additional kilograms of nuts 100 95 A B C Coffee (1000s of kg/day) • D E 20 20 Nuts (1000s of. .. production of one good Some resources better at coffee, some better at nuts C Coffee (1000s of kg/day) • D E 15 30 Nuts (1000s of kg/day) 2 22 The Principle of Increasing Opportunity Cost Maximum coffee:... cost of one kilogram of coffee increases to nuts No trade: 3.4 nuts and 3.4 coffee each With trade: 12 nuts and 12 coffee each 2 21 Production Possibilities for an Economy • Two goods: coffee