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AP Macroeconomics. Comparative Advantage FRQ - 2010B #1; 2008 #3. David Ricardo. English economist responsible for promoting comparative advantage as the basis of trade. Absolute Advantage v. Comparative Advantage. Absolute Advantage - PowerPoint PPT PresentationTRANSCRIPT
AP MacroeconomicsComparative Advantage
FRQ - 2010B #1; 2008 #3
David Ricardo
• English economist responsible for promoting comparative advantage as the basis of trade
Absolute Advantage v. Comparative Advantage
• Absolute Advantage– Individual – exists when a person can
produce more of a certain good/service than someone else in the same amount of time.
– National- exists when a country can produce more of a good/service than another country can in the same time period.
• Comparative Advantage– Individual/National- exists when an
individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation
Specialization
• Individuals and Countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want/need. How will specialization within a country influence the factors of production?
ExampleBake Cakes
Make Pizza
Juniors 2 cakes/hr. 6 pizzas/hr.
Seniors 4 cakes/hr. 8 pizzas/hr.
30
30
12
18
20
10
8
4
Coffee Coffee
Wheat Wheat
Absolute Advantage? Should the U.S. and Absolute Advantage? Should the U.S. and Brazil specialize and trade?Brazil specialize and trade?
Even though the U.S. has an absolute advantage in both goods – it should specialize and trade.
Step 1: Set up the problemStep 2: Identify Production Maximums
Coffee WheatU.S.
Brazil
Step 2: Reduce RatiosStep 3: Identify Opportunity CostStep 4: Compare Costs --- lowest has CA
Coffee: Wheat:
30
Brazil U.S.
30
20 10
1 1
2 1
(1W) (1C)
(1/2 W) (2C)
Step 1: Set up the problemStep 2: Identify production prior to specializationStep 3: Total production in each product prior to specializationStep 4: Identify maximum possible production of each product
with specialization according to comparative advantageStep 5: Compare output before/after specialization and trade
Coffee WheatU.S. Brazil
BeforeAfterGain
12 18
8 4
20 22
20 30
+8
Step 1: Identify original reduced ratios for each countryStep 2: Terms of trade fall between the limits set by the ratiosStep 3: Trading possibilities are the maximums set by the ratios
U.S. 1 C = 1 W
Brazil 2C = 1/2 W
PossiblePossibleTerm ofTerm ofTradeTrade
1.5C = 1W
Both nations benefit from 1.5C traded for 1W. Prior to trade, theU.S. gave up 1W for each coffee. With trade, the U.S. can receive1.5C for each unit of wheat. Before trade, Brazil gave up 2C for eachunit of wheat. With trade, Brazil gives up only 1.5C for each wheat.
U.S. 1 C = 1 W
Brazil 2C = 1 W
Trading Possibilities:Trading Possibilities:
PossiblePossibleTerm ofTerm ofTradeTrade
1C < 1W < 2C
1.5C = 1W
Should the U.S. and Brazil specialize and trade?Should the U.S. and Brazil specialize and trade?
Why: Efficiency Argument and Output ArgumentMore efficient useefficient use of scarce global resources • The U.S. gives up 1 coffee for each wheat / Brazil gives up 2 coffees for each wheat --- The U.S. gives up less to produce wheat.• Brazil gives up ½ wheat for each coffee / U.S. gives up 1 wheat for each coffee --- Brazil gives up less to produce coffee.Gains from trade --- more can be produced from the same resources• 8 additional units of wheat can be produced through specialization and8 additional units of wheat can be produced through specialization and tradetrade
Distinguishing:
Input/Output Problems
Distinguishing input from output problems.
• An OUTPUT problem presents the data as products produced given a set of resources. (ex. Number of pens produced)
• An INPUT problem presents the data as amount of resources needed to produce a fixed amount of output. (ex. Number of labor hours to produce 1 bushel)
• When identifying absolute advantage, input problems change the scenario from who can produce the most to who can produce a given product with the least amount of resources.
Which type of problem?• Acres to produce one unit of each.
• Input problem
Apples Pears
Tom 10 5
Sam 6 2
Absolute Advantage?• Acres to produce one unit of each.
• Who has the absolute advantage in apples and pears?
Sam
Apples Pears
Tom 10 5
Sam 6 2
Explanation• Acres to produce one unit of each.
• Sam has an absolute advantage in both pears and apples because he can produce 1 unit of each in fewer acres than Tom. Absolute advantage in INPUT problems is based on using the LEAST amount of resources to produce the given unit(s) of product.
Apples Pears
Tom 10 5
Sam 6 2
Input or Output problem?• Number caught per day.
Output problem
Trout Bass
Tom 4 6
Sam 24 12
Absolute Advantage?• Number caught per day.
• Which guy has the absolute advantage in the production of each product?
Sam
Trout Bass
Tom 4 6
Sam 24 12
Explanation:• Number caught per day.
• Sam has an absolute advantage in catching both trout and bass as he can
catch more of each than Tom in one day’s time.
Trout Bass
Tom 4 6
Sam 24 12
Input or Output Problem?• Days to produce one unit of each.
• Input problem
Cars Planes
XYZ Corp. 8 10
QKFX Corp.
15 12
Explanation:• Days to produce one unit of each.
• This is an input problem as it refers to how many days (work days for labor) will
be needed to produce 1 unit. The problem is phrased in terms of resources used
rather than products produced.
Cars Planes
XYZ Corp. 8 10
QKFX Corp.
15 12
Absolute Disadvantage?• Days to produce one unit of each.
• Which corporation has an absolute disadvantage in the production of
both products?QKFX
Cars Planes
XYZ Corp. 8 10
QKFX Corp.
15 12
Explanation:• Days to produce one unit of each.
• XYZ has an absolute advantage in producing both cars and planes because it
can produce 1 unit of each in less time (days) than QKFX. This means that QKFX
has an absolute disadvantage in producing both products. QKFX uses more
days to produce both products.
Cars Planes
XYZ Corp. 8 10
QKFX Corp.
15 12
Input or Output Problem?• To produce the following from one
ton of olives.
Output problem
Canned Olives
Olive Oil
Zaire 60 10
Colombia 24 8
Explanation?• To produce the following from one ton
of olives.
• This is an output problem because it is the number produced (output in
canned olives and olive oil) from a given unit of resources (1 ton of olives)
Canned Olives
Olive Oil
Zaire 60 10
Colombia 24 8
Absolute Advantage?• To produce the following from one
ton of olives.
• Which nation has the absolute advantage in both products?
Zaire
Canned Olives
Olive Oil
Zaire 60 10
Colombia 24 8
Explanation:• To produce the following from one ton
of olives.
• Zaire has an absolute advantage in producing both products because it can produce more given the unit of
resources available (1 ton of olives).
Canned Olives
Olive Oil
Zaire 60 10
Colombia 24 8
FRQ – 2003 #3• Assume that two countries, Atlantis and Xanadu, have equal
amounts of resources. Atlantis can produce 30 cars • or 10 tractors or any combination, as shown by the line MN in the
figure above. Xanadu can produce 20 cars or • 40 tractors or any combination, as shown by the line PQ in the
figure above. • (a) Which country has an absolute advantage in the production of
tractors? Explain how you determined your • answer. • (b) Which country has a comparative advantage in the production
of cars? Using the concept of opportunity • cost, explain how you determined your answer. • (c) If the two countries specialize and trade with each other, which
country will import cars? Explain why. • (d) If the terms of trade are such that one car can be exchanged
for one tractor, explain how Atlantis will benefit • from such trade