PerspectivesMercantilist Thought• 1500-1750• Belief: Gold is wealth• Belief: Trade is a zero-sum game -you can't have a winner without a loserAdam Smith • Challenged Mercantilist view in 1776• "Wealth of Nations" is NOT about gold• Trade can be mutually beneficial• Specialize based on absolute advantage- lowest absolute cost (resources)David Ricardo• Built upon Smith's perspective• Specialize using comparative advantage- lowest opportunity cost (what you could have done instead)• Provides a more general rule than SmithModeling Comparative Advantage2 regions- Buena Vista and Muchas Agua2 activities- growing rice and growing coffee beansIn buena vista…4 days for rice …3 days for coffee360 days of productive timeIn Muchas Agua…1 day for rice …2 days for coffee180 days of productive timeMax rice?Max Coffee?Max Output Rice Coffee BeansBuena Vista 90 OR 120Muchas Agua 180 OR 90Tasks:Production possibilities graphsAbsolute advantageOpportunity costsComparative advantageWhat do you recommend? Why?At first we assume autarky:Autarky means no trade.Autarky ConsumptionTotal Consumption Rice Coffee BeansBuena Vista 45 AND 60Muchas Agua 90 AND 45Total across board 135 105Absolute advantage: lowest absolute cost per unitWho is the fastest? Who has to use less resources?Rice- BV in 4 days, MA in 1 dayMuchas Agua has the absolute adv. in riceCoffee-BV in 3 days, MA in 2 daysMuchas Agua has the absolute adv. in coffeeWhy would they want to trade?Opportunity Cost (per unit) Rice Coffee BeansBuena Vista 4/3 pounds ¾ bushelMuchas Agua ½ pound 2.0 bushelsLook at slope!Comparative Adv.- lowest opp costBV has comparative advantage in coffee>>>>should specialize in coffeeMA has comparative advantage in rice>>>>should specialize in riceSpecialized ProductionMax Output Rice Coffee BeansBuena Vista 0 120Muchas Agua 180 0Autarky Coffee: 105 poundsAutarky Rice: 135 bushelsSpecialized Coffee: 120 poundsSpecialized Rice: 180 bushelsFREE
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