Outline

2. Primer
1

Comparative Advantage

Production Possibilities Frontier (PPF)

Leshui He
Bates College

Leshui He (Bates, Economics)

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Leshui He (Bates, Economics)

Comparative Advantage

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Comparative Advantage

Specialization and Exchange

Absolute Advantage vs. Comparative Advantage

Why do people outsource things they can do themselves?

almost all doctors hire front desk receptionists
mowing, weeding, etc.
Have you hired someone to do something you can? why?

discussion
Joe Jamailknown in the legal profession as The King of Torts, is the
most renowned trial lawyer in American history
Should Joe Jamail write his own will?

Beth has absolute advantage relative to Paula.

Beth requires less absolute amount of resources to perform any task comparing to Paula.

Paula has absolute disadvantage relative to Beth.

Paula requires more absolute amount of resources to perform any task comparing to Beth.

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Leshui He (Bates, Economics)

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Comparative Advantage

Comparative Advantage

Absolute Advantage vs. Comparative Advantage

Absolute Advantage vs. Comparative Advantage

We can derive the opportunity costs from the above info...

Beth has comparative advantage relative to Paula in repairing bicycles.

Beth has lower opportunity cost in repairing bicycles.

Paula has comparative advantage relative to Beth in updating web pages.

Paula has lower opportunity cost in updating web pages.

Whats different?
Remark
absolute disadvantage no comparative advantage
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Principles of Macroeconomics

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Leshui He (Bates, Economics)

Comparative Advantage

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Comparative Advantage

Another Example

Summing up for now...

cost (in unit of resources, $) of

making a serving of cake

cost (in unit of resources, $) of

making a baked dish

Abbys Bakery

$10

$20

Bobbys Restaurant

$15

$12

absolute advantage

comparative advantage

absolute amount of resources

opportunity cost

not always exits

(almost) always exits

Q1. Given the above info., does Abby/Bobby has absolute advantage relative to each other? No!
cost
Q2. What are their opportunity costs of making each product?
opportunity cost (in unit of dishes) of
making a serving of cake

Principles of Macroeconomics

always exists?

opportunity cost (in unit of cakes) of

making a baked dish

Abbys Bakery

0.5

Bobbys Restaurant

1.25

0.8

Q3. Who has comparative advantage over which product?

Abby has comparative advantage in producing cake.
Bobby has comparative advantage in producing dishes.

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Leshui He (Bates, Economics)

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Comparative Advantage

Comparative Advantage

Comparative Advantage Gains from Trade

Abbys Bakery
Bobbys Restaurant

cost (in unit of resources, $) of

making a serving of cake

cost (in unit of resources, $) of

making a baked dish

$10

$20

$15

Comparative Advantage Gains from Trade (cont.)

cost (in unit of resources, $) of
making a serving of cake

cost (in unit of resources, $) of

making a baked dish

Abbys Bakery

$10

$20

Bobbys Restaurant

$15

$12

$12

For this miniature society...

If you were Abby, how much products will you make with $120? ...depends on your preferences...
(case no-specialization no-trade) 10 (servings of) cakes & 8 dishes
(case specialization no-trade) 12 cakes & 10 dishes (but not great at individual level...)

...if splitting $120 equally, can get 6 servings of cake & 3 dishes

If you were Bobby, how much products will you make with $120? ...also depends on preferences...
What if they specialize and trade? Can it be better off than case no-specialization no-trade?
...if splitting $120 equally, can get 4 servings of cake & 5 dishes

Specialize and trade is always better than no-specialization no-trade.

For this miniature society of Abby & Bobby, the total products they enjoy are
(case no-specialization no-trade) 10 (servings of) cakes & 8 dishes

Why?
When specialize, A&B have 12 cakes & 10 dishes...
give 6/3 to A; 4/5 to B (no-specialization no-trade)...
still have 2 cakes and 2 dishes left!
Dividing them btw. A&B whichever way, no one will be worse off than no-specialization no-trade.

If Abby only makes cakes, Bobby only makes dishes, how much can they produce?
(case specialization no-trade) 12 cakes & 10 dishes!

better than producing separately! ...but not great if each prefers some variety...
case specialize & trade is better than any no-specialization no-trade case! (why?)
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Principles of Macroeconomics

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Leshui He (Bates, Economics)

Comparative Advantage

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Comparative Advantage

Comparative Advantage Gains from Trade (cont.)

What Leads to Comparative Advantage?

endowment/resources determines comparative advantage

Remark
( The principle of comparative advantage, pg.37) Everyone does best when each person (or each
country) concentrates on the activities for which his or her opportunity cost is lowest (the activity with
comparative advantage).

acquired

endowed

individual level

skills

talent

country level

innovation

natural endowment

caveats
For the above argument to hold, we implicitly assumed trading is costless.
At the country level, trade is generally good for both countries. But detailed structural changes in industries
have to happen during specializations, some individual citizens can be worse off, through, for example,
unemployment.

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South Korea has comparative advantage in manufacturing electronics.

Australia has comparative advantage in producing wool.
Your examples?

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Principles of Macroeconomics

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Production Possibilities Frontier (PPF)

Production Possibilities Frontier (PPF)

Production Possibilities Frontier (PPF)

PPF and Comparative Advantage

We presented the choice of using limited resources

toward two different products with tables.

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Different approachgraphical
Production Possibilities Frontier (PPF) a.k.a.
Production Possibilities Curve in textbook
A curve represents the bound/limit/tradeoff in
production.

12
8

output y

output y

P P FA

PPF carves the space into 3 regions

6 8 PPF
12
output x

What are the opportunity costs for A and B,

respectively, to produce x and y?

12

A0.5 x for every y; 2 x for every y

B2 x for every y; 0.5 y for every x

8
6

P P FB
Who has comparative advantage in x (y)?

1. below/left of PPFinefficient
2. on PPFefficient
3. above/right of PPFunattainable

can draw PPF for two producers, A and B

A has comparative advantage in y

B has comparative advantage in x

can find opportunity costs from PPF (through slope),

opportunity cost of...

6 8

12
output x

24

...producing each x is 2 units of y

...producing each y is 0.5 unit of x

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Principles of Macroeconomics

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Leshui He (Bates, Economics)

Production Possibilities Frontier (PPF)

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Production Possibilities Frontier (PPF)

PPF, Comparative Advantage and Trade

36

Principles of Macroeconomics

PPF, Comparative Advantage and Trade

36

S&T

24

What are the possible combinations of x and y

that A and B can produce together? Lets
aggregate their PPFs to find out!

P P FA

point Yall in on Y
point Xall in on X
point S&Tfully specialize and trade!

12
P P FB
0

24
output x

Leshui He (Bates, Economics)

24
P P FA
P P FB
0

36

Principles of Macroeconomics

...From point Y, if A & B wants to produce 1 unit

of x, who should produce it?
The guy/girl with lower opportunity costB!
...this goes until point S&T, until B cannot
produce any more x...
A kicks in on x, but then... higher opportunity
cost! This is why there is a kink on the total
(blue) PPF! And why it bends outward!

S&T

12

X
12

output y

output y

The aggregate PPF bends outward! Why?

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X
12

24
output x

Leshui He (Bates, Economics)

As we produce more and more of a product, the

opportunity cost increases!

36

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Production Possibilities Frontier (PPF)

Production Possibilities Frontier (PPF)

The Principle of Increasing Opportunity Cost

Economy-wide PPF

Remark
( The Principle of Increasing Opportunity Cost, a.k.a. Low Hanging Fruit Principle)
In expanding the production of any good, first employ those resources with the lowest opportunity cost, and
only afterward turn to resources with higher opportunity costs.

output y

unattainable
efficient

inefficient

For a large enough economy, many producers

are involved. Constructing an aggregate PPF
generates a smooth PPF
no more kinks

bends outward (increasing opportunity cost)

three regions

unattainable (outside of PPF)

efficient (on PPF)
inefficient (inside PPF)

output x

Leshui He (Bates, Economics)

Principles of Macroeconomics

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Leshui He (Bates, Economics)

Production Possibilities Frontier (PPF)

Principles of Macroeconomics

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Production Possibilities Frontier (PPF)

Shifts in PPF

Why not Specialize More?

output y

specialization gains from trade, why not specialize more?

increase in productive resourcesmajor drive
for economic growth

output x

trade has to be easy enough...

Adam Smithpopulation density
institutional restrictions
culture
technology

labor
capital
knowledge/technology

Y
On PPF, this change is represented by a
outward-shift of the PPF

output y

comments?

better combinations become attainable

output x
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