The Law of Comparative Advantage

1. The Law of Comparative Advantage

2. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

3. What are the opportunity costs? • For you, the opportunity cost of typing one paper is ironing 3 shirts • For your roommate the opportunity cost of typing one paper is 12 shirts • You have the lower opportunity cost in typing papers and should specialize in that output

4. What are the opportunity costs? • For you, the opportunity cost of ironing one shirt is typing 1/3 of a paper • For your roommate the opportunity cost of ironing one shirt is typing 1/12 of a paper • Your roommate has the lower opportunity cost in ironing and should specialize in that output • Does this solution work?

5. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

6. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

7. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

8. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

9. How do you know who has the comparative advantage in each good? How did we decide who should specialize in what? • Three step method • Not as complicated as it looks…don’t be intimidated • The concept of of comparative advantage is an exciting one, and explains why people specialize, why countries specialize, and why trade is so important!

10. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output Hint: Remember to put people or countries in rows and products or services in columns. The data will not always be given to you in a neat matrix as shown above. You will need to set it up.

11. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output 6 2 5 1

12. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output 6 2 3 1/3 5 1 5 1/5

13. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output 6 2 3 1/3 5 1 5 1/5 • You specialize in typing where you have a comparative advantage • Your roommate specializes in ironing, where he has a comparative advantage

14. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

15. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output

16. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output 10 30 12 60

17. The Law of Comparative Advantage  Individual with lower opportunity cost of a particular output should specialize in that output 3 1/3 10 30 5 1/5 12 60 You specialize in typing where you have a comparative advantage Your roommate specializes in ironing, where he has a comparative advantage

18. International trade • The same ideas that apply to individuals apply to countries as well • Where were your toys and clothing produced? • Who leads the world in movie special effects? • “Terms of trade” determine what the prices will be for traded products. We will return to this concept later in the semester.