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Learning Objectives: Understand
1. The Principle of Comparative Advantage
2. The Principle of Increasing Opportunity Cost (also called the Low-Hanging-Fruit Principle)
3. Factors that shift the menu of production possibilities
4. The role of comparative advantage in international trade
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Do It Yourself?
Joe Jamail, a highly successful Lebanese-American trial attorney, employs another attorney to write his will Writing your own will Opportunity cost of 2 hours Hiring someone to spend 4 hours
on your will Making the right economic choice
Do It Yourself only whenOpportunity cost < hired cost
2 hours
$10,000+
$3,200
Priceless
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Production Advantages: Previous Example
From the previous example: Jamail has an absolute advantage at
preparing his will Because he can perform that task than
another lawyer Other lawyer has a comparative
advantage at preparing the will Because his opportunity cost of
performing that task is lower than Jamail’s
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Production Advantages
Definitions Absolute advantage
Lowest production cost one person has an absolute advantage over
another if he or she takes fewer hours to perform a task than the other person
Comparative advantage Lower opportunity cost than someone else one person has a comparative advantage over
another if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost
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The Principle of Comparative Advantage
The Principle of Comparative AdvantageEveryone does best when each concentrates
on the activity with the lowest opportunity cost
Opens doors for specialization have you ever met an engineer who is also a medical
doctor? Or a mechanic who is also a professor? defines the basis for trade
among people and countries
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Comparative Advantage Example
Production Times
Web Update Bike Repair
Ayden 20 minutes 10 minutes
Ghadah 30 minutes 30 minutesAyden and Ghadah can each update web pages and repair bikes but Ayden has an absolute advantage in both
Because it takes Ayden less time to perform each task
• In an 8 hour day, we can translate this into quantities
Production Output
Web Update Bike Repair
Ayden 24 48
Ghadah 16 16
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Comparative Advantage Example
Opportunity Cost
Web Update Bike Repair
Ayden 2 repairs 0.5 update
Ghadah 1 repair 1 update
Production Output
Web Update Bike Repair
Ayden 24 48
Ghadah 16 16
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Comparative Advantage Example
Production Times
Web Update Bike Repair
Ayden 20 minutes 10 minutes
Ghadah 30 minutes 30 minutes
Hourly Output Web Update Bike Repair
Ayden 3 updates 6 repairs
Ghadah 2 updates 2 repairs
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Comparative Advantage Example
Assume that 16 web updates are ordered Ayden spends half his time at each activity: 12
updates and 24 repairs Ghadah produces the remaining 4 updates and
spends the last 6 hours of the day making 12 repairs Total output 16 updates and 36 repairs
If specialization occurs then:16 updates and 48 repairs 12 more repairs for the same inputs!
Hourly Output Web Update Bike Repair
Ayden 3 updates 6 repairs
Ghadah 2 updates 2 repairs
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Another Example
This table shows output per hour Principle of Comparative Advantage
is the same Look at opportunity cost per unit
Hourly Output Web Update Bike Repair
Rasha 2 updates 1 repair
Amr 3 updates 3 repairs
Opportunity Cost
Web Update Bike Repair
Rasha ½ repair 2 updates
Amr 1 repair 1 update
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The Principle of Comparative Advantage
Two parties have different opportunity costs for two activities Concentrate on the activities of your
lowest opportunity cost Identify the task with which the person or
country has a comparative advantage in Total value of output increases with
specialization • By specializing on producing tasks with which a
person or a country has a comparative advantage, the opportunity for trade exists
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Sources of Comparative Advantage
Where does comparative advantage come from? At the individual level
Talent• Education, training and experience
At the national level Natural resources Cultures or societal norms
• Languages• Institutions
- Value placed on craftsmanship- Support for entrepreneurship
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Moroccan Track & Field
What has happened to Moroccan Track and Field?
Moroccan athletes won gold medals in the following Olympics games:
1984: 2 gold medals 1988: 1 gold medal 1992: 1 gold medal 2004: 2 gold medals
Ethiopians specialized in 10,000-meter competition, thus showing unsurpassed domination.
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Pearl Diving in the Gulf
What happened to pearl diving in the Arabian Gulf?
Pearls from the Gulf are known to be the finest in the world.
Arabian Gulf had comparative advantage in pearl diving due to arid climate which made sea-related activities the only economically-viable options.
Global economic depression of 1930s reduced global demand for pearls, coinciding with the introduction of Japanese cultured pearls.
Cultured pearls were mass produced according to specific shape, size, and quality, thereby reducing costs and virtually destroying the natural pearl industry.
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Production Possibilities Curve (PPC)
A graph of the combinations of two goods that can be produced with given level of resources
Definitions Unattainable point Attainable point
Inefficient point Efficient point
Scarcity Principle Give up one good to get
another Nuts (kg/day)
A
B
UnattainableCombination
C
Inefficient Combination
DC
offe
e (
kg/d
ay)
24
16
8
4 8 12
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Fatima’s Production Possibilities
Two goods: coffee and nuts Work 6 hours per day Has nimble fingers
better for picking coffee
1 hour of labor= 4 kg of coffee OR= 2 kg of nuts
Graph shows options Negative slope
Cof
fee
(kg/
day)
Nuts (kg/day)
16
8
4 8
24 A
B
C
D12
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Fatima’s Opportunity Cost
Moving from A to B: Marginal cost : – 8 coffee Marginal benefit: 4 nuts
Loss in coffeeGain in nuts
• Opportunity cost of 1 nut is
2 coffee
Moving from C to A: Marginal cost: – 8 nut Marginal benefit: 16 coffee
Loss in nutsGain in coffee
• Opportunity cost of 1 coffee is ½ nut
Cof
fee
(kg/
day)
Nuts (kg/day)
16
8
4 8
24 A
B
C
D12
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PPC and Opportunity Cost
Hints: Since Fatima’s PPC is a straight line, its slope is
constant The absolute value of the slope of Fatima’s PPC is
the ratio of its vertical intercept to its horizontal intercept:
(24 kg of coffee/day)/(12 kg of nuts/day) = (2 kg of coffee)/(1 kg of nuts) This ratio means that Fatima’s opportunity cost of an additional kg of nuts is 2 kg of coffee
To say that Fatima’s opportunity cost of an additional kg of nuts is 2 kg of coffee is thus equivalent to saying that her opportunity cost of a kg of coffee is ½ kg of nuts.
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Kamal 's Production Possibilities
Work 6 hours per day Productivity determines the slope of the PPC 1 hour of labor
= 4 kg of nuts OR= 2 kg of coffee
Opportunity cost Marginal cost: – 4 coffee Marginal benefit: 8 nuts Tom's opportunity cost of
1 coffee is 2 nuts His opportunity cost of
1 nut is ½ coffee Nuts (kg/day)
Cof
fee
(kg
/day
)4
8
8 16
A
B
C
D
12
24
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Kamal meets Fatima
PPCs show comparative advantage Fatima's curve is
steeper, better for coffee
Kamal's curve is flatter, better for nuts
Comparative advantage is a comparison
To get 1 coffee Fatima gives up ½ nuts Kamal gives up 2 nuts
Nuts (kg/day)
12
24
Kamal’s PPC
24
12
Fatima’s PPC
Cof
fee
(kg
/day
)
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Gains from Specialization and Trade
Without trade, each person can consume along his production possibilities curve What you produce determines what you
consumeWith trade, each person's consumption
can be greater than production Produce according to comparative
advantage Trade to get what you want
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Gains from Specialization and Trade
Fatima and Kamal
exchange12 nuts, 12
coffee
8
8
Nuts (kg/day)
12
24
24
12
Cof
fee
(kg
/day
)
Preferred diet is half nuts, half coffee
No trade: 8 kg of coffee and 8 kg of nuts Total output is 32
pounds Specialization gives
each person 12 kg of each good
48 total kg
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Gains from Specialization and Trade
Benefits increase when differences in opportunity cost increase
Fatima's opportunity cost of nuts increase to 6 coffee
Kamal's opportunity cost of coffee increases to 6 nuts
No trade: 3.4 nuts and 3.4 coffee each
With trade: 12 nuts and 12 coffee each
Trade benefit
s
Trade benefit
s
No trade
No trade
24
244
4
12
Fatima's PPC
12
Cof
fee
(kg/
day)
Nuts (kg/day)
Kamal's PPC
With tradeWith trade
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Production Possibilities for an Economy
Two goods: coffee and nuts
Multiple people Different opportunity
costs
Intercepts show maximum production of one good
Some resources better at coffe, some better at nuts
Nuts (1000s of kg/day)
100
80
Cof
fee
(10
00s
of k
g/da
y)
E
A B C
D1520
9095
20 30 7577
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The Principle of Increasing Opportunity Cost
Maximum coffee: 100,000 kg / day Give up 5,000 kg coffee, get 20,000 kg of nuts (A
B) Give up another 5,000 kg of coffee, get an 10,000
additional kg of nuts (B C)
Nuts (1000s of kg/day)
100
80
Cof
fee
(10
00s
of k
g/da
y)
E
A B C
D1520
9095
20 30 7577
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The Principle of Increasing Opportunity Cost
Dec
reas
ing
prod
uctiv
ity
Res
ourc
es U
sed
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The Principle of Increasing Opportunity Cost
PPC is bow-shaped because of increasing opportunity cost Also known as the “low-hanging-fruit principle”
1st: It is easier to pick the low-hanging-fruit 2nd: if the fruit picker does not want to pick
the whole tree then it is still a better choice since the high-hanging-fruit are more difficult to get to
3rd: if the fruit picker wants to pick the whole tree then it is still a better choice since he can enjoy some fast revenue from the sales of the easy to pick sooner
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The Dynamic Economy
What shifts the PPC? A PPC represents current choices
Changes in choices occur over time due to
• More resources- Investment in capital - Population growth
• Improvements in technology- More specialization: start-up and switching
costs• Increases in knowledge
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Shifts in PPC
Nuts
Cof
fee
Neutral Technical Change
Nuts
Cof
fee
Technical Change in Nuts
Technical Change in Coffee
Nuts
Cof
fee
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Some Countries Resist Specialization
Specialization is easier when Population density passes a threshold Markets are connected
Transportation for goods Communications for services
Legal framework supports business Financial markets enable start-ups
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Too Much Specialization?
Imagine this: Your hair stylist only cuts blonde hair A professor for each chapter! Seven bookstores, each open a
different day of the week A grocery store for every type of food
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Comparative Advantage and International Trade
Principle of Comparative Advantage and gains from trade apply worldwide Potentially large gains from trading
with different and distant countriesControversial trade
Benefits the society broadly Costs are concentrated
Some industries People who lose their jobs
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