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Comparative Advantage

Comparative Advantage. Quick Introduction. Brief History. David Ricardo introduces the concept of comparative advantage in 1819 ( On the Principles of Political Economy and Taxation . London: John Murray, 1819.) Important because: Shows that it is optimal for countries to specialize and trade

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Comparative Advantage

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  1. Comparative Advantage Quick Introduction

  2. Brief History • David Ricardo introduces the concept of comparative advantage in 1819 (On the Principles of Political Economy and Taxation. London: John Murray, 1819.) • Important because: • Shows that it is optimal for countries to specialize and trade • Show that EVERY country has a comparative advantage at something

  3. Absolute advantage • Absolute advantage came before Ricardo proved that: • every country has a comparative advantage in something; • and everyone is better off if each country specializes in the product for which it has a comparative advantage • Absolute advantage in a good means that fewer resources (labor, energy) are used to produce a unit of that good relative to another country.

  4. Absolute Advantage

  5. Absolute Advantage • The US is better than Mexico at producing computers (uses fewer resources). So the US has an absolute advantage in computers. • Mexico uses fewer resources than the US to produce shirts. Mexico has the absolute advantage in shirts.

  6. Absolute Advantage • The US should specialize in computers. • Mexico should specialize in shirts.

  7. Comparative advantage

  8. Comparative advantage • US is better at both computers and vaccines. US has the absolute advantage in both. • Should countries still specialize?

  9. Comparative advantage • Should countries still specialize? • Yes, countries should specialize. The country with a comparative advantage in computers should produce computers. The country with a comparative advantage in vaccines, should produce vaccines.

  10. Opportunity cost • Opportunity cost is the best alternative an economic agent has when she makes a choice.

  11. Comparative Advantage • To identify a country’s comparative advantage in a product, we compare opportunity costs for the product across the two countries.

  12. Comparative advantage • Who has the comparative advantage in computers? (i.e., who has the lowest opportunity cost for producing computers?) • What is the US’ opportunity cost for computers? (How many vaccines does the US give up to produce 1 computer?) • What is Mexico’s opportunity cost for computers? (How many vaccines does Mexico give up to produce 1 computer?)

  13. Comparative Advantage • A comparative advantage in a good is a lower opportunity cost for producing that good.

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