Comparative Advantage1. Absolute Advantage2. Comparative AdvantageAbsolute vs. Comparative Adv.Implication: SpecializationLimits of SpecializationComparative Advantage and Marginal CostGun Production - SueGun Production (cont’d)Butter Production - SueButter Production (cont’d)Marginal CostThe Marginal Cost CurveThe Marginal Cost Curve (cont’d)Application: The FirmThe Firm (Cont’d)The Firm’s Marginal Cost Curve (Preview)SummaryComparative AdvantageOrganizing production at lowest cost.1. Absolute Advantage The ability to produce more of a good, using the same amount of resources2. Comparative AdvantageThe ability to produce the good at the lowest costAbsolute vs. Comparative Adv.•Lawyer & Secretary•“Gilligan’s Island”•Lebron•Professors and TA’sImplication: Specialization•Gains to be exploited by focusing on “what you do best” and then trade•Specialization creates wealth•Specialization is everywhereLimits of SpecializationWhy isn’t everything specialized?•The feasibility of specialization is limited by the extent of the market•Life would be pretty boring that waySpecialization also means society becomes increasingly interdependentComparative Advantage and Marginal CostConsider the following production capabilities:GUNS BUTTERSUE 8 4CHARLES 3 3DAPHNE 1 2Who has the comparative advantage in producing guns?Gun Production - Sue•If Sue makes 8 guns, she sacrifices 4 units of butter – she sacrifices ½ units of butter for every gun she makesGun Production (cont’d)•Charles sacrifices 1 unit of butter for every gun he makes•Daphne sacrifices 2 units of butter for every gun she makesSue is thus the low cost gun producer.Butter Production - Sue•If Sue makes 4 units of butter, she sacrifices 8 guns•Sue thus sacrifices 2 guns for every unit of butter she makesButter Production (cont’d)•Charles sacrifices 1 gun for every unit of butter he makes•Daphne sacrifices ½ a gun for every unit of butter she makesDaphne is thus the low cost butter producer.Marginal CostMarginal cost is the added (incremental) cost for producing one more unit of a good:MC = Δ TC / Δ QWhere TC = Total Cost = Fixed Cost + Variable Cost = FC + VCThe Marginal Cost CurveSuppose our three-person society wanted to make guns. Who would they first put to gun production?What is the most amount of guns they could make?The Marginal Cost Curve (cont’d) 2 1 1/2 8 11 12GunsMC(Butter)Application: The Firm•A firm behaves in a similar manner •inputs (like labor and capital) are put to their best use first•As firm objectives change inputs are reallocated as necessary to their second-best uses, driving up costsThe Firm (Cont’d)• Thus the cost to produce each additional unit gets higher and higher• The supply curve describes how the firm’s costs change as output is increased (i.e., their willingness to sell)The Firm’s Marginal Cost Curve (Preview)QMCS = MCSummary•If you can produce the most – absolute advantage•If you can produce at lowest cost – comparative advantage•Marginal cost curve upward sloping – derived by allocating resources to their lowest cost
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