Absolute Advantage Comparative AdvantageEQ: How do we gain from trade?

What was the most importantdocument written in 1776?

He is my great, great, great, great, great grandfather on my mother’s side

What made The Wealth of Nations “THE” most important document written in 1776?

Adam Smith wrote about a pin factory.What did they call the workers in thepin factory?Just a bunch of pinheads.

When he first observed the factory,he noticed that each worker wasproducing his or her own pins. By the end of the day, the total production by each worker was 20 pins. He stated that each worker should specialize in the production stage rather than produce his or her own pins. Through specialization, the total output by the factory increased to 48,000 pins per day.(Page 11, Wealth of Nations)

One person draws the wire.One person straightens the wire.One person cuts the wire.One person points the wire.One person grinds the wire at the top to receive the head of the pin.One person makes the head of the pin.One person attaches the head to the pin.

I am going to prove that specializationworks. I am going to name a state andyou tell me what that state specializesin:

Idaho PotatoesFlorida OrangesTexas Oil or cattleMichigan AutomobilesNevada Any illegal activity that

you can think of

Absolute and Comparative Advantage

Betty types 120 w.p.m. with 0 errorsJim types 60 w.p.m. with 0 errors

Who should do the typing, Betty or Jim?

Betty. Why?Betty can type ABSOLUTELY faster thanJim can. What type of advantage doesBetty have over Jim?

Absolute Advantage

Absolute Advantage--

One entity can produce somethingeither faster than or greater thananother entity.

I forgot to tell you--Betty is a lawyer.A lawyer earns $60 an hour.A secretary earns $6 an hour.

A 600-word document has to be typed, how long does it take eachperson to type this document?

How long does it take Betty to typethis document?How long does it take Jim to typethis document?

Who should do the typing?

Jim

Comparative Advantage

One entity can produce somethingat a LOWER MARGINAL OPPORTUNITYPRODUCTION COST than anotherentity

Take absolute advantage and KICKIT OUT THE DOOR. The more important of the two is--

Comparative Advantage

Who has an absolute advantage in TVs? Fertilizer?

Japan U.S.

TV

Fertilizer

TV

Fertilizer

80

20

50

50

Input (IOU) or Output (OOO)?

• Input = other goes under• Output = other goes over

Who has the comparative advantage in the production of TV’s? Fertilizer?

Fertilizer TVsJapan 20

1 ton Fertilizer = 4 TV’s

80

1 TV = ¼ ton Fertilizer

U.S. 50

1 ton Fertilizer = 1 TV

50

1 TV = 1 ton Fertilizer

What is Japan’s opportunity cost of 1

ton fertilizer?

What is Japan’s opportunity cost of 1

TV?

What is the U.S.’s cost of 1 ton

fertilizer?What is the U.S.’s

opportunity cost of 1 TV?

Terms of trade – 1 TV = 3/4 tons of fertilizer

Japan U.S.

TV

Fertilizer

TV

Fertilizer

80

20

50

5060

Consumption Possibilities Curve

62.5

Summary

• Please explain in your own words why trade makes us wealthier.