The Law of Comparative Advantage Powerpoint

The Law of Comparative Advantage PowerPoint

This information goes with the Law of Comparative Advantage Economiracle PowerPoint.

I. Slide 1 a. As we know, the Law of Comparative Advantage says that producers should specialize where they have the lowest opportunity cost.

b. Having a comparative advantage is not the same as being the best at something. In fact, someone can be completely unskilled at doing something, yet still have a comparative advantage at doing it! How can that happen you might ask?

c. Well, over the next several minutes I will show you how to calculate comparative advantage and how it is applied on both the consumer and producer side of the industry.

II. To fully understand we need to go on a tour of Comparative Advantage a three hour tour: III. Slide 2 a. Gilligan’s Island a.i. Keys and Cells phones a.ii. Absolute Advantage a.iii. If the Skipper has an absolute advantage, does Gilligan have a comparative advantage? IV. Slide 3 a. Gilligan a.i. The only way to figure out what their comparative advantage is we need to figure out what their opportunity cost is. a.ii. Remember this point: opportunity cost is what you are giving up to do something else or what you are giving up for something else. a.iii. When we figure it out we always look in measurable units of 1. a.iv. Let’s look at Gilligan’s O.C. V. Slide 4 a. Skipper a.i. Now that we know Gilligan’s and Skipper’s o.c. let’s compare them VI. Slide 5 a. As consumers we apply the law of comparative advantage virtually every day.

VII. Slide 6 a. Pizza a.i. Suppose Skipper decides to have pizza for dinner. a.i.1. He can purchase a pizza for $8 at a local restaurant. a.i.2. If he produces the pizza at home, he calculates the opportunity cost of the pizza to be $10, including the value of time and the cost of ingredients. a.i.3. In this case, Skipper would exchange for the pizza because others can produce (probably tastier) pizzas at a lower opportunity cost than he can. a.i.4. His gain from the exchange will be the difference between his opportunity cost of production ($10) and the cost through exchange ($8), or a benefit of $2. a.ii. Now lets assume Gilligan is a good cook whose uncle is a restaurant supplier. a.ii.1. Gilligan’s opportunity cost to produce the pizza may be only $5, so he should produce the pizza at home. a.ii.2. Indeed, he might want to go into the pizza business since his opportunity cost is less than the prevailing price. a.ii.3. If Gilligan can make pizza for $5 and sell it for $8, his gain from exchange will be $3 on each pizza. a.iii. We implicitly think through this same sort of calculation for each item we decide to purchase or produce ourselves, whether it’s pizza or plumbing repairs or a brake job on our car. a.iv. We look at our opportunity cost compare it against the alternative and then make a decision. VIII. Slide 8 a. Michael Jordon a.i. Let’s assume that these are the only two professional alternatives these guys have a.ii. What is Jordan’s opportunity cost for 10 hours painting? $100,000 a.iii. (He’d be giving up 100,000 to make 400) a.iv. What is Joe’s Opportunity cost for painting: $10 a.v. (He’d be giving up 10 dollars to make 200) a.vi. Joe Painter, who is worse at both skills, has as lower opportunity cost, thus a comparative advantage, in one: painting

b. Understanding Comparative Advantage helps us to recognize the implications of specialization and trade. To understand its managerial relevance I would like to turn the time over to Anthony and Bonnie. c. It is important to understand that opportunity cost is defined by available alternative rather than by absolute levels of skill and abilities

IX. ACCOUNTANT: The following example illustrates the importance of available alternatives rather than level of skill in determining opportunity cost. Susan is more capable than John in both accounting and law. Susan can generate an income of $100,000 as an accountant and an income of $90,000 as a lawyer while John can generate an income of $80,000 as either an accountant or a lawyer. Fortunately for John, Susan cannot do both jobs. When she chooses accounting over law because her opportunities are greater in accounting, an opportunity for employment in law then opens for John.

A person with adequate but not outstanding cooking skills may still find work as a chef. Of course, the wage may only be adequate as well. Another person with rudimentary skills at repairing cars may find employment as a mechanic’s helper if he/she does not have better skills in other areas. The law of comparative advantage implies that there is an economic activity that each person, each plot of land, each machine or other resources can perform at a low opportunity cost.

Economists summarize the effect of opportunity cost on specialization and trade in the Law of Comparative Advantage: Every individual, group, or nation can produce at least one good or service at a lower opportunity cost than others. To maximize their standard of living they should specialize in the production of such goods or services. As long as opportunity costs differ for various individuals or groups, specialization and trade will be beneficial to the parties involved.

Implications of the Law of Comparative Advantage Full Employment of Resources First, the law of comparative advantage generates a tendency toward full employment of all resources in their most preferred use in an economy. This principle explains why the engineer who designs a car employs someone else to repair it and why authors of textbooks on typing do not type their own manuscripts. On the other hand, the operation of the law of comparative advantage also explains why there is so much mediocrity in the world; this economic principle means that the best people for the job are only rarely doing the actual work. Most individuals are in their particular jobs because they are low-cost producers and not because they are particularly competent in that area.

The law of comparative advantage leads not only to full employment of resources but to full employment of resources in their best possible use.

Widest Possible Gains from Exchange The second implication of the law of comparative advantage is that it creates the widest possible gains from exchange or trade. Consider the complex process of automobile production. An automobile contains thousands of parts and many different types of materials such as steel, aluminum, chrome, rubber, glass, and plastic. Over 50,000 businesses supply various auto parts to automobile factories and assembly plants in the United States. Automobile production draws on the skills of engineers, computer programmers, tool and die makers, accountants, secretaries, skilled assemblers, and other labor.

In the absence of this specialization and exchange process, we would all be living in caves—being 100 percent self-sufficient and poor.

Economic Interdependence The third implication of the law of comparative advantage is that it promotes a great deal of economic interdependency. Complex objects involve exchanges among thousands of individuals from various parts of the globe. Consequently, we are all completely at the mercy of one another for maintaining our high standard of living. This interdependency frightens some people, who equate the word with economic and political vulnerability, making them want to become self-sufficient. However, true self-sufficiency is also self-limiting, and requires those who choose that lifestyle to live relatively hard lives, literally off the sweat of their own brows, without modern conveniences and comforts. Given this fact, most of us are willing to accept interdependency as a necessary evil in return for the high standard of living specialization and exchange offers us. Some argue that the economic interdependency stemming from the law of comparative advantage also links countries together politically, thereby reducing chances of war and violence.