Comparative Advantage and Trade

1. Comparative Advantage and Trade

2. $6,000 $5,000 $4,000 Per capita income (in 1990 dollars) $3,000 $2,000 $1,000 0 500 1000 1500 2010 Economic Growth In the Past Two Thousand Years WHY?

3. The Economics of Babe Ruth

4. 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 *Means New York Yankee Right Fielder led the 1918 11* .300 league 1920 54* .376 1923 41* .393* 1927 60* .356

5. Comparative Advantage • Comparative Advantage—the relatively most productive use of a resource • Hitting was the Babe’s comparative advantage • Very good pitcher—played every 4-5 days • Great hitter—played every day and changed the game forever • Specialized—pitched a total of only 5 games after 1919

6. A B Production Possibilities Without Trade Production Possibilities Curves for Pakistan and Belgium What does each country do best? Hint: Think opportunity costs. 5 D 4 Pakistan Textiles (in thousands of yards) 3 2 1 Belgium E 1 2 3 4 Chocolate (in tons)

7. A B Specialization and Trade How could they get to point C where each country can consume 2,000 tons of fabric and 2 tons of chocolate? 5 D 4 Pakistan Textiles (in thousands of yards) 3 C 2 Belgium 1 E 1 2 3 4 Chocolate (in tons)

8. 5 D 4 Pakistan Textiles (in thousands of yards) 3 C A 2 Belgium B 1 E 1 2 3 4 Chocolate (in tons) Specialization and Comparative Advantage For Pakistan the opportunity cost of one ton of chocolate is 4000 yards of textiles. For Belgium the opportunity cost of one ton of chocolate is 250 yards of textiles. 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).

9. Comparative Advantage and the Combined PPC F (0,5) 5 The combined PPC is the curve connecting points F, H, and G. 4 H (4,4) Pakistan 3 Note how much more they can have if they specialize and trade Textiles (in thousands of yards) .C (2,2) 2 Belgium 1 G (5,0) 1 2 3 4 5 Chocolate (in tons)

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.

11. 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?

12. 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

13. 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?

14. 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.

15. 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.