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Lecture 4

Lecture 4 - Comparative Advantage and the Gains from Trade (w/ Recordings) .pdf

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James Pesando

Example 2 Production Possibilities (Per Week) "Same example as before John & Jane from Lecture 3" Cloth Corn John 10 2 Jane 16 8 Jane has Absolute Advantage in production of cloth and corn. Q: Can Jane and John both still gain from trade? A: Yes, comparative advantage, NOT absolute advantage, is what matters OC of Producing One Unit of Cloth Corn John 0.2 corn 5 cloth Jane 0.5 corn 2 cloth Jane now has an absolute advantage in the production of both cloth and corn. Yet John has a comparative advantage in the production of cloth, while Jane has a comparative advantage in the production of corn. Observation: Jane is now twice as productive in production of both cloth and corn as in Ex. 1 (where she could produce 8 cloth or 4 corn), so her OC of producing each has not changed. Before trade, John and Jane divide their time equally between the production of clothing and corn. Production (Before Trade) Cloth Corn John 5 1 Jane 8 4 Total 13 5 After trade, John specializes completely in the production of cloth, while Jane now allocates 75% of her time to the production of corn. Production (After Trade) Cloth Corn John 10 0 Jane 4 6 Total 14 (+1) 6 (+1) With unchanged resources (PPFs), total output is higher if John/Jane specialize in production of the good in which each has a comparative advantage Comparative advantage, NOT absolute advantage, matters (an intuitive example) Bill Gates (Microsoft): Should he write computer program? 1. Time to write computer program Gates: 3 hours Consultant: 10 hours 2. Questions Does Gates have a comparative advantage? What is OC of time? 3. Next best alternative Gates earn $10,000 per hour as executive Consultant earns $100 per h
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