ModuleComparativeAdvantage and Trade

KRUGMAN'SMACROECONOMICS for AP*

4

Margaret Ray and David Anderson

HousekeepingHousekeeping

Read Module 4 – do C/U and tackle the test.

Quiz early next week on comparative advantage.

What you will learnWhat you will learn

in thisin this ModuleModule::

• How trade leads to gains for an individual or an economy

• The difference between absolute advantage and comparative advantage

• How comparative advantage leads to gains from trade in the global marketplace

Why do nations trade?Why do nations trade?

????

Why do Nations Trade?Why do Nations Trade?

• Specialization leads to….

• Gains from trade

PROVE IT!

Absolute AdvantageAbsolute Advantage

States Apples Timber

Oregon 10 40

Washington 40 10

Oregon WashingtonApples Apples

40 40

35 35

30 30

25 25

20 20

15 15

10 10

5 50 0

5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40

Timber Timber

Pairs – What would you do?Pairs – What would you do?

• One player - OR

• Other player - WA

Terms of Trade

1 apple

for

1 timber

Absolute AdvantageAbsolute Advantage

States Apples Timber

Oregon 40(20)

Washington 40(20)

20

20

Gains from TradeGains from Trade

States Apples Timber

Oregon 5 to 20 20

Washington 20 5 to 20

Total 25 to 40

25 to 40

Oregon WashingtonApples Apples

40 40

35 35

30 30

25 25

20 20

15 15

10 10

5 5

0 0

5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40

Timber Timber

Absolute AdvantageAbsolute Advantage

Country has an absolute advantage when it can produce more of a good than other countries with the same amount of resources.

Comparative AdvantageComparative Advantage

Lawn mowing example:

Lawn Mowing

Comparative AdvantageComparative Advantage

Comparative advantage arises because two parties have different opportunity costs.

Should WA Trade?Should WA Trade?

States Apples Timber

Oregon 10 40

Washington 50 50

Oregon WashingtonApples Apples

50 50

45 45

40 40

35 35

30 30

25 25

20 20

15 15

10 10

5 50 0

5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40 45 50

Timber Timber

Pairs – What would you do?Pairs – What would you do?

• One player - OR

• Other player - WA

Terms of trade

2 timber for 1 apple

Should WA Trade?Should WA Trade?

States Apples Timber

Oregon 40(20)

Washington 50(40)

20

10

Oregon WashingtonApples Apples

50 50

45 45

40 40

35 35

30 30

25 25

20 20

15 15

10 10

5 5

0 0

5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40 45 50

Timber Timber

Terms of tradeTerms of trade

Terms of trade is the amount of one product exchanged for another expressed as a ratio. This ratio will lie between the opportunity costs for each trading partner.

Summary of Key ConceptsSummary of Key Concepts

• Absolute Advantage

• Comparative Advantage

• Terms of Trade

Fish and ChipsFish and Chips

Chips Fish Chips Fish Chips Fish Chips FishUK 25 50 50 25 40USA 15 20 80 25 40

Total 40 70 50 80 50 80 0 0

Terms of trade FishChips 25

No trade Specialization Export 1/2 ?

40

More PracticeMore Practice

• NZ and Spain

• China and USA

Input Oriented ProblemsInput Oriented Problems

Hrs / product

Donuts Coffee

Livingston 8 4

Montclair 24 8

Absolute advantage?Comparative advantage?

Gains from trade?

Convert input questions into Convert input questions into opportunity costs.opportunity costs.

Hrs / product

Donuts Coffee

Livingston 1unit 2 units

Montclair 1 unit 3 units

Montclair has a comparative advantage in coffee, and Livingston has one in donuts.