How do we determine what to produce Absolute Advantage Absolute advantage is when someone is the best at doing something The USA is the best at producing entertainment Nick Saban is the best at coaching college football ID: 777678
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Slide1
Absolute & Comparative Advantage
How do we determine what to produce?
Slide2Absolute Advantage
Absolute advantage is when someone is the best at doing something
The USA is the best at producing entertainment
Nick
Saban
is the best at coaching college football
Lebron James is the best basketball player
Are there cases where someone might be the best at something but it’s better for them to not do it?
Slide3Comparative Advantage
If Lebron James is the best basketball player and the best teacher, while Jenkins is a weak basketball player and a moderate teacher, who should do which task?
Comparative Advantage is when a person can produce something at a lower
opportunity cost
than anyone else.
Slide4Comparative Advantage
In this scenario:
Jenkins has the comparative advantage in teaching because it cost him less (in giving up a weak basketball game) in order to specialize in teaching.
Lebron James has the comparative advantage in basketball because it costs him less (in giving up comparatively low teacher pay) to specialize in basketball.
Slide5Comparative Advantage
To find comparative advantage, DO NOT compare Absolute advantage:
ability of an individual, or firm, or country to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources
Instead compare their opportunity costs
Value of the best alternative
Slide6Comparative Advantage
USA has an absolute advantage in airplane production and coffee production when compared to Guatemala
So why does Guatemala produce significantly more coffee than the USA?
Simple, USA has to give up too many airplane producers (a very complex field) to grow coffee.
Slide7Before Specialization
Example: Salmon and Coffee
Before Specialization
Hours Worked
Production
Alaska
4 (making salmon)
5 pounds of salmon
4 (making coffee)
1 pound
of coffee
Brazil
4 (making
salmon)1 pound of salmon4 (making coffee)5 pounds of coffee
If Alaska works 8 hours with NO TRADE they have 5lbs salmon and 1lb of coffee
If Brazil works for 8 hours with NO TRADE they have 1lb of salmon and 5lbs of coffee
Slide8After Specialization
After
Specialization
Hours Worked
Production
Alaska
8 (making salmon)
10 pounds
of salmon
Brazil
8 (making coffee)
10 pounds
of coffee
If they specialize in what they make best Alaska spends all it’s time making salmon while Brazil only makes coffee.Alaska produces 10 pounds of salmon, but no coffee.Brazil produces 10 pounds of coffee but no salmon.How can the Alaskan make this work to its benefit?
Slide9After Trade:
After
Trade
Coffee
Salmon
Alaska
5 pounds coffee
5 pounds
of salmon
Brazil
5 pounds coffee
5 pounds
of salmon
TRADE! If he sells half his salmon to Brazil and uses the money to buy 5 pounds of coffee, he will still have 5 pounds of salmon and now he’ll have 5 pounds of coffee too!Before specialization the Alaskan only had 1 pound of coffee—so in in the end, he comes out with an extra 4 pounds of coffee and didn’t have to do any additional work!
Slide10Sample Problems
Cars
Computers
United
States
16
8
Japan
8
6
Who has
Absolute
Advantage in cars?
United StatesWho has Absolute Advantage in computers?United States
Slide11Sample Problems
Cars
Computers
United
States
16
8
Japan
8
6
Who has
Comparative
Advantage in computers?
Japan.Why?
Slide12Sample Problems
Cars
Computers
United
States
16
8
Japan
8
6
HINT: always put the item asked about in the denominator
United States’ opportunity cost of computers:
16 2
----- = ----- = 2 cars 8 1Japan’s opportunity cost of computers: 8 4 ---- = ----- = 1.33 cars 6 3
Slide13Sample Problems
Cars
Computers
United
States
16
8
Japan
8
6
Who has comparative advantage in cars?
United States has the comparative advantage because
they only have to give up 1/2 of a computer versus 3/4 that Japan has to give up, in order to produce 1 car.
Slide14Sample Problems
Cars
Computers
United
States
16
8
Japan
8
6
United States’ opportunity cost of specializing in cars:
8 1
----- = ----- = 1/2 of a computer
16 2Japan’s opportunity cost of specializing in cars:6 3---- = ----- = 3/4 of a computer8 4
Slide15Video ClipEconomics in 60 Seconds
http://www.youtube.com/watch?v=38hvvAzgXZY
Slide16You Try
Bananas
Rice
Fiji
10
5
China
10
2
Who has absolute advantage in bananas?
Who has absolute advantage in rice?
Who has comparative advantage in rice?
Who has comparative advantage in bananas?
Slide17You Try
Bananas
Rice
Fiji
10
5
China
10
2
Who has absolute advantage in bananas?
Neither-both produce 10 bananas
Who has absolute advantage in rice?
Fiji has absolute advantage (5-2)
Slide18Comparative Advantage - Bananas
Bananas
Rice
Fiji
10
5
China
10
2
China
only gives up 1/5 rice whereas Fiji has to give up 1/2 rice to produce 1 banana.
Fiji’s opportunity cost of bananas: 5 1
----- = ----- = 1/2 rice
10 2China’s opportunity cost of bananas: 2 1 ---- = ----- = 1/5 rice 10 5
Slide19Comparative Advantage - Rice
Bananas
Rice
Fiji
10
5
China
10
2
Fiji
only gives up 2 bananas whereas China has to give up 5 bananas to produce 1 rice.
Fiji’s opportunity cost of Rice: 10 2
----- = ----- = 2 bananas
5 1China’s opportunity cost of Rice: 10 5 ---- = ----- = 5 bananas 2 1
Slide20Sample Problems
A look at the worksheet (Lesson 1, Activity 2)
Mike Debbie
Vacuuming 60 min. 45 min.
Wash dishes 30 min. 45 min.
What is Mike’s opp. cost of vacuuming in terms of washing dishes? (In other words, how many loads of dishes does he have to give up to vacuum the room)
Answer—2 loads of dishes (60 min./30 min.) = 2
Let’s try another one
Slide21Sample Problems
Mike Debbie
Vacuuming 60 min. 45 min.
Wash dishes 30 min. 45 min.
What is Mike’s opp. cost of doing dishes in terms of vacuuming? (In other words, how much vacuuming does he have to give up to do dishes)
Answer—
1/2 of a room vacuumed (30 min./60 min.) = .5
What about Debbie?
She has to give up 1 room vacuumed for 1 load of dishes (45/45=1)
Slide22Sample Problems
So if Debbie has to give up 1 room vacuumed to do a load of dishes meanwhile Mike has to give up ½ a room to do a load of dishes; who has the comparative advantage of doing dishes?
Mike does because it only costs him ½ a room to Debbie’s 1 room.