Economics 2 Professor Christina Romer Spring 2018 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2018 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2018 Professor David Romer LECTURE 2 COMPARATIVE ADVANTAGE AND THE GAINS FROM SPECIALIZATION January 18, 2018 I. O VERVIEW II. T HE K EY R OLE OF D IFFERENCES IN R ELATIVE A BILITY A. Intuition B.

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Economics 2 Professor Christina Romer Spring 2018 Professor David Romer LECTURE 2 COMPARATIVE ADVANTAGE AND THE GAINS FROM SPECIALIZATION January 18, 2018 I. OVERVIEW

  • II. THE KEY ROLE OF DIFFERENCES IN RELATIVE ABILITY
  • A. Intuition
  • B. Example: Specialization within a household
  • C. Reciprocal absolute advantage
  • 1. Definition of absolute advantage
  • 2. Comparing outcomes without and with specialization
  • D. Comparative advantage
  • 1. Definition of comparative advantage
  • 2. Comparing outcomes without and with specialization
  • 3. Reciprocal absolute advantage is just a special case of comparative advantage
  • III. OPPORTUNITY COST AND COMPARATIVE ADVANTAGE
  • A. Comparative advantage means that a producer has a lower opportunity cost
  • B. There are gains from specialization when opportunity cost differs
  • C. Comparative advantage is a relative concept
  • IV. SPECIALIZATION AND THE CURVATURE OF THE PRODUCTION POSSIBILITIES CURVE
  • A. Example: Specialization in a two-person economy
  • B. PPC of two people combined without specialization
  • C. PPC of two people combined with specialization
  • D. What do we learn from this example?
  • E. Will both parties gain from specialization?

V. REAL-WORLD EXAMPLE: SHOULD CALIFORNIA GROW RICE?

  • A. Facts about California agriculture and water use
  • B. Relative opportunity cost of growing rice in California and Arkansas
  • C. Are we specializing along the lines of comparative advantage?
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LECTURE 2 Comparative Advantage and the Gains from Specialization

January 18, 2018

Economics 2 Christina Romer Spring 2018 David Romer

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Announcements

  • It is essential that you attend section this week.
  • Some hints on taking notes and reading the

textbook.

  • Reminder: please put away all electronic devices.
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  • I. OVERVIEW
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Two Fundamental Building Blocks

  • Scarcity, choice, and opportunity cost.
  • Comparative advantage and the gains from

specialization.

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  • II. THE KEY ROLE OF DIFFERENCES IN RELATIVE

ABILITY

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Example: Specialization within a Household

  • Two activities: dishwashing and painting.
  • There are 3 walls that need painting (and many

dirty dishes).

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Reciprocal Absolute Advantage

Walls

Dishes Abilities (per hour) C. 4 12 D. 2 20 No Specialization (Each paints ½ hr. and washes ½ hr.) C. 2 6 D. 1 10 3 16 Specialization (C. paints ¾ hr. and washes ¼ hr.; D. washes 1 hr.) C. 3 3 D. 20 3 23

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Absolute Advantage

  • Someone or something can produce more with a

given amount of resources.

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Comparative Advantage

Walls

Dishes Abilities (per hour) C. 4 24 D. 2 20 No Specialization (Each paints ½ hr. and washes ½ hr.) C. 2 12 D. 1 10 3 22 Specialization (C. paints ¾ hr. and washes ¼ hr.; D. washes 1 hr.) C. 3 6 D. 20 3 26

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Comparative Advantage

  • Someone or something is relatively more

productive at one activity than at another.

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Messages

  • Comparative advantage is necessary for there to

be gains from specialization.

  • Reciprocal absolute advantage is just a special

case of comparative advantage.

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  • III. OPPORTUNITY COST AND COMPARATIVE

ADVANTAGE

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Opportunity Cost and Comparative Advantage

Abilities (per hour) C. 4 walls or 24 dishes D. 2 walls or 20 dishes Opportunity Cost of 1 Wall C. 24/4 = 6 dishes D. 20/2 = 10 dishes Opportunity Cost of 1 Dish C. 4/24 = 1/6 wall D. 2/20 = 1/10 wall Lower opportunity cost implies comparative advantage.

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Some Observations

  • There are gains from specialization when
  • pportunity cost differs across producers.
  • How much we want to specialize depends on how

many of the two activities need to be done.

  • Comparative advantage is inherently a relative

concept.

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  • IV. SPECIALIZATION AND THE CURVATURE OF THE

PRODUCTION POSSIBILITIES CURVE

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Example: Specialization in a Two-Person Economy

  • Two goods: fish and coconuts.
  • Abilities:
  • In an hour, Robinson can catch 1 fish or

gather 1 coconut.

  • In an hour, Friday can catch 8 fish or gather 2

coconuts.

  • Each of them works 6 hours a day.
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Production Possibilities Curve (PPC)

  • Diagram showing the combinations of two types
  • f goods that could be produced in an economy

just using all of the available inputs.

  • In this case, the two goods are fish and coconuts.
  • We will draw the PPC for a day.
  • Recall, the slope of the PPC is (minus) the
  • pportunity cost of the good on the horizontal

axis.

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Opportunity Cost When Robinson and Friday Allocate Their Time the Same Way (No Specialization)

  • In an hour, they could catch 9 fish (1 from

Robinson and 8 from Friday).

  • Or they could gather 3 coconuts (1 from Robinson

and 2 from Friday).

  • So, they trade off 9 fish for 3 coconuts.
  • The opportunity cost of 1 coconut is 3 fish.
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Island PPC without Specialization

0 0 Coconuts Fish 54 18

Slope is −3, because the opportunity cost of gathering 1 coconut for the two combined without specialization is 3 fish.

PPC

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Individual Abilities and Opportunity Costs

  • In an hour, Robinson could catch 1 fish or gather 1

coconut.

  • So, the opportunity cost of having Robinson

gather 1 coconut is 1 fish.

  • In an hour, Friday could catch 8 fish or gather 2

coconut.

  • So, the opportunity cost of having Friday

gather 1 coconut is 4 fish.

  • Robinson is the low opportunity cost provider of

coconuts.

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Island PPC with Specialization

0 0 Coconuts Fish 54 18 PPC Slope = −4 Slope = −1 48 6

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Gains from Specialization

0 0 Coconuts Fish 54 18 PPC with Specialization 48 6 PPC without Specialization Gains from Specialization

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What Do We Learn from This Example?

  • There are gains from specialization when
  • pportunity cost differs across producers and

production is organized according to comparative advantage.

  • This explains why the PPC for a country is likely to

be bowed out.

  • One determinant of the size of the gains from

specialization is the difference in opportunity cost.

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Will Both Robinson and Friday Benefit from Specialization?

  • Simple Answer: As long as there is no coercion, if

two parties choose to specialize and trade, both must be benefitting.

  • More complicated answer: In a market system,

prices will tend to adjust to ensure that both parties gain from specialization and trade.

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Implications of the Gains from Specialization

  • It explains why we see trade at all levels.
  • To have trade, we need markets.
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  • V. REAL-WORLD EXAMPLE: SHOULD CALIFORNIA

GROW RICE?

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Source, Congressional Research Service, “California Agricultural Production and Irrigated Water Use,” 2015.

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Source, Congressional Research Service, “California Agricultural Production and Irrigated Water Use,” 2015.

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Is California the Low-Opportunity-Cost Rice Producer in the U.S.?

  • What does California give up to grow rice?
  • What do other rice-compatible states (such as

Arkansas) give up to grow rice?

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Source, Congressional Research Service, “California Agricultural Production and Irrigated Water Use,” 2015.