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Comparative Advantage and Trade

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Economic Growth In the Past Two Thousand Years

$6,000
Per capita income (in 1990 dollars)

$5,000 $4,000 WHY?

$3,000
$2,000 $1,000 0 500

1000

1500

2010

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The Economics of Babe Ruth

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Babe Ruth Statistics

Boston Red Sox Pitcher
1915 18-8 2.44 1916 23-12 1.75* 1917 24-13 2.01 1918 13-7 2.22 New York Yankee Right Fielder 1918 11* .300 1920 54* .376 1923 41* .393* 1927 60* .356
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*Means led the league

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Comparative Advantage

Comparative Advantagethe relatively

most productive use of a resource Hitting was the Babes comparative advantage

Very good pitcherplayed every 4-5 days Great hitterplayed every day and changed

Specializedpitched a total of only 5

games after 1919
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the game forever

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Production Possibilities Without Trade

Textiles (in thousands of yards) 5 4 D 3 2 1

Production Possibilities Curves for Pakistan and Belgium

What does each country do Pakistan best? Hint: Think opportunity A costs.
B
E

Belgium
4

1 2 3 Chocolate (in tons)

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2-7

Specialization and Trade

Textiles (in thousands of yards) How could they get to point C where each country can consume 2,000 tons of fabric and 2 tons of chocolate?

5 4 D 3 2 1 A

Pakistan
C

Belgium
B
E

1 2 3 Chocolate (in tons)

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2-8

Specialization and Comparative Advantage

Textiles (in thousands of yards)
For Pakistan the opportunity cost of one ton of chocolate is 4000 yards of textiles.

5 4 D 3 2 1 A

For Belgium the opportunity cost of one ton of chocolate is 250 yards of textiles.

Pakistan
C B

Belgium has the comparative advantage in chocolate and specializes producing 4 tons (point E). Pakistan has the comparative advantage in textiles and specializes producing 4000 yards (point D).

Belgium
E

1 2 3 Chocolate (in tons)

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2-9

Comparative Advantage and the Combined PPC

5 F (0,5)
Textiles (in thousands of yards) 4 3 2 1 The combined PPC is the curve connecting points F, H, and G. H (4,4)

Pakistan

Note how much more they can have if they specialize and trade

C (2,2)

Belgium
G (5,0) 1 2 3 4 Chocolate (in tons) 5

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2-10

U.S. Textile Production and Trade

Two hundred years ago, the U.S. had a

comparative advantage in textile production. Now countries with cheaper labor, such as Bangladesh, have the comparative advantage in textiles. The gains from trade are higher wages for workers in Bangladesh and lower-priced cloth for U.S. consumers.
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Comparative Advantage Review

Suppose that the U.S. can produce 100 computer chips or 100 video games in one hour. Japan can produce 40 computer chips or 80 video games in one hour. What is the opportunity cost of computer chips in each country? In which product should each country specialize?

The U.S. is more efficient in producing both computer chips and video games. Can the U.S. benefit by trading with Japan?
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In the U.S. the opportunity cost of 1 video game is 80/80 = 1 computer chip.
In Japan the opportunity cost of 1 computer chip is 80/40 = 2 video games. U.S. should specialize in computer chips. Produces 100 per hour Japan should specialize in video games. Produces 80 per hour They agree to trade 1 computer chip for 1.5 video games U.S. gets video games for 2/3 of a computer chip Japan gets computer chips for 1.5 video games Both countries have reduced their opportunity costs
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Comparative Advantage and Outsourcing

Outsourcing : The relocation of production once

done in the U.S. to foreign countries.

Outsourcing occurs because of comparative advantage

What is the comparative advantage of countries such as India and China? What is the comparative advantage of the U.S.?

What economic activities are being outsourced?

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Globalization

Globalization: The increasing

integration of economies, cultures, and institutions across the world.

The positive effect of globalization is

that it provides larger markets than the domestic economy.

The negative effect is that it results in

increased competition.
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Law of One Price

Wages of similar workers in one country
will not differ significantly from the wages of workers in another institutionally similar country.

If the U.S. loses its comparative advantage

based on technology and institutional structure, U.S. wages will decrease relative to wages in many other countries.
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