Jim Whitney Economics 311

Friday, January 27, 2012
 

David Ricardo's trade according to comparative advantage

Situation: Suppose that the U.S. and Malawi produce and consume only two products, personal computers (PCs) and garments (G). Both products are produced under competitive conditions through the use of labor time.

Key concepts:
  1. Absolute advantage (AA): A nation has an absolute advantage in a product relative to its trading partner(s) when it can produce more output with an equal amount of inputs (or the same amount of output with a smaller amount of inputs).
  2. Comparative advantage (CA): A nation has a comparative advantage in a product relative to its trading partner(s) when it can produce its output with (1) a relatively high productivity margin or, equivalently, with (2) a lower opportunity cost.
  3. Opportunity cost (OC): the sacrifice you make to get something you want.
    For example, to get more PCs, you must switch labor (L) from garments to PCs. Consider switching 1 unit of labor:
    Garments lost   units lost in the contracting industry  
    OC of each extra PC =  -------------   ( =  --------------------------------------)  
    PCs gained   units gained in the expanding industry  

Case 1:

 Output (Q) per labor-year
PCs Garments
United States 120 600
Malawi 6 30
   Relative productivity: Output per L-year: US / Malawi 20  

  1. Which country will have the higher wage? _______________
    How did you decide?



     

  2. Will Malawi and the U.S. trade with each other? Check "Yes" or "No" and answer the resulting question(s) in the space below:
    ____ Yes: (1) Which country will export PCs? Garments? (2) How did you decide?
    ____ No: How did you decide?



     

Continued on back side.

 

 

Case 2.1: Compare relative productivity margins:

 Output (Q) per labor-year
PCs Garments
United States 120 600
Malawi 3 30
   Relative productivity: US/Malawi    

 

Case 2.2:  Compare
opportunity costs

 Output (Q) per labor-year Opportunity cost of each...
PCs Garments PC Garment
United States 120 600   1/5 PCs
Malawi 3 30    

Will Malawi and the U.S. trade with each other? Check "Yes" or "No" and answer the resulting question(s) in the space below:
____ Yes: (1) Which country will export PCs? Garments? (2) How did you decide?
____ No: How did you decide?