Economics 2 Professor Christina Romer Spring 2020 Professor David - - PDF document

Economics 2 Professor Christina Romer Spring 2020 Professor David Romer LECTURE 2 COMPARATIVE ADVANTAGE AND THE GAINS FROM SPECIALIZATION January 23, 2020 I. OVERVIEW II. THE KEY ROLE OF DIFFERENCES IN RELATIVE ABILITY

• A. Intuition
• B. Example: Specialization within a household
• C. Reciprocal absolute advantage
• D. Comparative advantage
• E. What do we learn from this example?
• 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. Visualizing and understanding the gains from specialization
• 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?
• D. If not, why not?

LECTURE 2 Comparative Advantage and the Gains from Specialization

January 23, 2020

Economics 2 Christina Romer Spring 2020 David Romer

Announcements

• Reminder: please put away all electronic devices.
• It is essential that you attend section this week.
• Some hints on taking notes and reading the

textbook.

• Please talk loudly so that the whole class can hear.

• I. OVERVIEW

Two Fundamental Building Blocks

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

specialization.

• II. THE KEY ROLE OF DIFFERENCES IN

RELATIVE ABILITY

Example: Specialization within a Household

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

dirty dishes).

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

Absolute Advantage

• Someone or something can produce more with a

given amount of resources.

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

Comparative Advantage

• Someone or something is relatively more

productive at one activity than at another.

Messages

• Comparative advantage is necessary for there to

be gains from specialization.

• Reciprocal absolute advantage is just a special

case of comparative advantage.

• III. OPPORTUNITY COST AND COMPARATIVE

ADVANTAGE

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.

Some Observations

• There are gains from specialization when
• pportunity cost differs.
• 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.

• IV. SPECIALIZATION AND THE CURVATURE OF THE

PRODUCTION POSSIBILITIES CURVE

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.

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.

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.

Island PPC without Specialization

00 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

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.

Island PPC with Specialization

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

Gains from Specialization

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

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.

Will Robinson and Friday both 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.

Implications of the Gains from Specialization

• It explains why we see trade at all levels.
• To have trade, we need markets.

• V. REAL-WORLD EXAMPLE:

SHOULD CALIFORNIA GROW RICE?

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

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

Source: USA Rice Federation, https://www.usarice.com/resources/market-information.

U.S. Rice Production by State

In Thousand CWT | 2015-2017

Is California the low-opportunity-cost rice producer in the U.S.?

• What does California give up to grow rice?
• Or, to put it another way, what are the likely

alternative uses of the resources (particularly the scarce water) used to grow rice?

• What do other rice-compatible states (such as

Arkansas) give up to grow rice?

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

Given that California almost surely isn’t the low-opportunity-cost rice producer:

• Does it make sense that California has specialized

(to some degree) in rice production?

• What might explain why this has happened?