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UA EC 110 - Comparative Advantage and Trade
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ECON 110 1st EditionLecture 4Outline of Last Lecture I. Circular Flow Diagrama. Details relationship between households and firmsb. Elements of the modeli. Actors1. Firmsa. Entities that utilize factors of production and turn out goods and servicesb. Buy resourcesc. Hire labord. Convert resources 2. Households a. Buy and consume goods and servicesb. Own and sell factors of production3. Marketsii. Factors of production are resources that the production process uses1. Land2. Labor3. Capital: not human input (equipment, supplies, etc.)c. This diagram excludes trade with economies of other nationsII. Production Possibilities Frontiera. Helps to show the most efficient production choicesb. Visible representation of all possible trade offsc. Frontier line can change with changes in available resourcesd. Example: capital goods vs. consumer goodsIII. Positive/Normative Statementsa. Positive statements attempt to describe the world objectively (descriptive analysis)b. Normative statements state how the world ought to be (prescriptive analysis)c. Studying economic phenomena vs. giving adviceOutline of Current Lecture I. Opportunity cost reviewII. Absolute advantageIII. Comparative advantage--trade and specializationIV. Questionsa. Why do people and nations choose to be economically independent?These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.b. How can trade make everyone better off?c. What is absolute advantage?d. What is comparative advantage?e. How are they similar/different?V. Interdependencea. Why do countries trade?b. How to comparative/absolute advantage affect trade?c. Examplesi. Law Businessii. Japan vs. U.S. ProductionCurrent Lecture – Comparative Advantage and TradeAbsolute advantage is the ability to produce a good using fewer inputs than another producer.Example: In example one, you as a lawyer can produce a 50 page paper in an hour, whereas your secretary can only produce 25 pages in an hour. You have absolute advantage in terms of paper production because you use less time to produce more.Comparative advantage is the ability to produce a good at a lower opportunity cost than another producer.Example: In example 3, Japan can produce a computer at the opportunity cost of 5 tons of wheat, while the opportunity cost for the U.S. to produce a computer is 10 tons of wheat. Therefore, Japan has comparative advantage in terms of production of computers.Example 1: A lawyer charges $200 an hour; their secretary is paid $25 an hour. The lawyer can type 50 pages an hour, and the secretary can type 25 pages and hour. - What's the opportunity cost when you prepare a 50 page document? o This takes you one hour, in which you could have earned $200 by practicing law, so the opportunity cost is $200.- What's they opportunity cost when your secretary prepares the same 50 page document?o This takes the person two hours, but we're not concerned with all the other things they could be doing, because you can be earning $400 during that time, thus gaining $350.Comparative advantage at work: nowadays, we see a lot of specialization, rather than a variety of activities at work. This produces a lower opportunity cost in general. Sometimes people do specialize, but it is hard to find a good example because usually people who pursue more than one thing pursue them at separate times. (Michael Jordan with baseball and basketball, actors, musicians, etc.) Economies and countries also specialize to some extent, i.e. America does not produce coffee because we do not have the land for it.Example 2: Aruba can produce 50 coolers or 20 radios. Iceland can produce 100 coolers or 25 radios. Iceland can produce more coolers and more radios; therefore Iceland has absolute advantage in both products. The opportunity cost of a cooler for Iceland is 1/4 of a radio, and this opportunity cost ofcooler for Aruba is 2/5 of a radio. In cooler production, Iceland has the comparative advantage because the opportunity cost is less. Now let's look at the flip side; Aruba's opportunity cost for a radio is 2.5 coolers. Icelandsopportunity cost for a radio is 4 coolers. Therefore in terms of radio production, Aruba had the comparative advantage because their opportunity cost is less. In conclusion, trade could be advantageous for both sides because of comparative advantage; it would be best for both countries if Aruba traded some radios for coolers with Iceland. Example 3: - Two countries: U.S. and Japan- Two products: computers and wheat- One resource: labor hoursThe U.S. has 50,000 hours of labor per month. The U.S. can produce 5000 tons of wheat or 500 computers.Japan has 30,000 hours of labor per month. Japan can produce 1000 tons of wheat or 200 computers.NOTE: Without trade, the U.S. Consumers get 250 computers and 2500 tons of wheat, meanwhile Japanese consumers get 100 computers and 500 tons of wheat (assuming that laboris divided evenly between the two products.) The U.S. has absolute advantage in production of both products because it can produce more in general. For the U.S., the opportunity cost of computers is 10 tons of wheat, and the opportunity cost of wheat is .10 computers. The opportunity cost for Japan for computers is 5 tons of wheat, and for wheat it is .20 computers. Therefore, Japan has comparative advantage in computers, but not in wheat. Trade could be advantageous for both


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UA EC 110 - Comparative Advantage and Trade

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