The Gains from Trade

Why do people specialize in the production of

a few goods or services and then trade?

Why don't people become self-sufficient

instead, producing everything they need?

Comparative advantage slide 1

 An Example
Suppose there are two people, McPherson and
Brown.

Both can produce Tacos and Spaghetti, but

they are not equally adept.

Comparative advantage slide 2

 McPherson's Daily Production
Possibilities
tacos

10 spaghetti

Comparative advantage slide 3

McPherson has preferences that make him
want to consume 4 tacos and 2 spaghetti.

[Show his consumption point on the graph.]

Comparative advantage slide 4

 McPherson's Daily Production
Possibilities
tacos

He consumes 4 tacos
and 2 spaghetti
5

10 spaghetti

Comparative advantage slide 5

 Brown's Daily Production
Possibilities
tacos
12
Brown

5
McPherson

10 12 spaghetti

Comparative advantage slide 6

Suppose that Brown consumes 5 spaghetti and
7 tacos.

[Show his consumption point on the graph.]

Comparative advantage slide 7

 Brown's Daily Production
Possibilities
tacos
12

Brown consumes 7
tacos and 5 spaghetti
5

10 12 spaghetti

Comparative advantage slide 8

Without specialization and trade here's where
they are in production and consumption:

S T
Brown 5 7
McPherson 2 4

Total 7 11

Comparative advantage slide 9

Absolute advantage: A person has an
absolute advantage in the production of a
good if he/she uses less inputs to produce a
unit of the good.

Notice that Brown has an "absolute

advantage" in the production of both goods.

Comparative advantage slide 10

Comparative advantage: A person has a
comparative advantage in the production of
a good if that person can produce an extra
unit of the good at lower opportunity cost.

Comparative advantage slide 11

Be sure you can answer these questions:

1) What's McPherson's cost of one more plate

of spaghetti?
2) What's Brown's cost of one more plate of
spaghetti?
3) Who has the "comparative advantage" in
spaghetti production?

Go to hidden slide
Comparative advantage slide 12
Now let McPherson specialize completely in
the production of spaghetti, and Brown
specialize completely in the production of
tacos.

Comparative advantage slide 14

The table at the right shows total production
with specialization. More is produced of
both goods.
No specialization Specialization
S T S T
Brown 5 7 Brown 0 12
McPherson 2 4 McPherson 10 0

Total 7 11 Total 10 12

Comparative advantage slide 15

If Brown and McPherson can arrange to
specialize and then trade, both can be better
off. There’s more of both goods!
In this case the gains from specialization are 3
plates of spaghetti and 1 taco.

Comparative advantage slide 16