Bellringer: Read about Tiger Woods’s dilemma written by N. Gregory Mankiw. Write the following question and answer on your bell ringer sheet below today’s date.

Should Tiger Woods mow his own lawn? Why or why not? Explain how people can benefit from specializing in certain tasks and trading.

Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let’s imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does this mean he should?

To answer this question, we can use the concepts of opportunity cost and comparative advantage. Let’s say that Woods can mow his lawn in 2 hours. In that same 2 hours, he could film a television commercial for Nike and earn $10,000. By contrast, Forrest Gump, the boy next door, can mow Woods’s law in 4 hours. In that same 4 hours, he could work at McDonald’s and earn $32. Who should mow Tiger’s grass?

In this example, Woods’s opportunity cost of mowing the lawn is $10,000 and Forrest’s opportunity cost is $32. Woods has an absolute advantage in mowing laws because he can do the work in less time. Yet Forrest has a comparative advantage in mowing lawns because he has the lower opportunity cost.

The gains from trade in this example are tremendous. Rather than mowing his own law, Woods should make the commercial and hire Forrest to mow the law.

EQ: How do you compute comparative advantage and terms of trade?

Agenda1. Bellringer-Tiger Woods’s Dilemma2. Lecture--Definitions3. Burt and Betty Role Play4. Lecture5. Practice Problems

Theory from David RicardoExplains the benefits of different individuals

(or countries) specializing in a task (mowing laws, making commercials) and then trading.

Comparative Advantage

Absolute advantage—the ability to produce more with the same amount of resources.

Comparative advantage—the ability to produce with the least amount of opportunity cost

Absolute vs. Comparative Advantage

Burt and Betty Role Play

1. Who is better at cleaning the dishes? Betty

2. If Bert and Betty work together, how many loads can they do in one hour?

3 loads—Betty can do two by herself and Bert can do one.

3. How many minutes would it take for them to wash one load of dishes working together?

20 minutes—one hour (60 minutes) divided by 3

Bert and Betty Role Play Questions

4. Who is better at sweeping up and taking out the trash?

Betty

5. If Bert and Betty work together, how many loads of trash can they do in one hour?

4 loads—Betty can do three by herself and Bert can do one.

6. How many minutes would it take for them to sweep up and take out 3 loads working together

45 minutes—one hour (60 minutes) divided by 4= 15 minutes x 3 loads=45

Bert and Betty Role Play Questions

Time to complete one sink full of dishes20 minutes

Time to complete three loads of trash45 minutes

Total time65 minutes

Option 1: Parents Plan to Work Together

Time for one sink full of dishes30 minutes

Time to complete 3 loads of trash3 hours

Total3 hours

Option 2: Betty does the dishesand Bert cleans the garage

Time to complete one sink full of dishes30 minutes

Time to complete 3 loads of trash1 hour

Total time=1 hour 30 minutes

Option 3: Betty should do it all

Time to complete one sink full of dishes1 hour (by himself)

Time to complete 3 loads of trash1 hour (by herself)

Total time 1 hour

Option 4: Specialization—Bert washes the dishes and Betty cleans the garage

Output problems=number of goods/services produced

Input problems=amount of time or other resources used to produce

Finding Comparative Advantage Output Problems

Dishwashing Sweeping

Betty 2 3

Bert 1 1

Step 1: Set up the problem in a table. Always set up the problems with the people

(countries in the first column Always doing it the same way=less confusion

Finding Comparative Advantage Output Problems

Dishwashing

Sweeping

Betty 2 3

Bert 1 1

Betty Bert

Dishwashing

2 1

Sweeping 3 1

Step 2: Find the opportunity cost for each person and task.

For output problems ONLY—put the opposite number on top and reduce the fraction (if needed)

Finding Comparative Advantage Output Problems

Dishwashing Sweeping

Betty 2 (3/2=1.5 sweeping)

3 (2/3 dishwashing)

Bert 1 (1/1=1 sweeping)

1 (1 dishwashing)

Step 3: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.

Who has the comparative advantage in dishwashing?

Look at the dishwashing columnSee who has the lowest number as the

opportunity cost.

Finding Comparative Advantage Output Problems

Dishwashing Sweeping

Betty 2 (3/2=1.5 sweeping)

3 (2/3 dishwashing)

Bert 1 (1/1= 1 sweeping)

1 (1 dishwashing)

Who has the comparative advantage in sweeping?

Look at the sweeping columnSee who has the lowest number as the

opportunity cost.

Finding Comparative Advantage Output Problems

Dishwashing Sweeping

Betty 2 (3/2=1.5 sweeping)

3 (2/3 dishwashing)

Bert 1 (1/1=1 sweeping)

1 (1 dishwashing)

You may be given the entire production possibilities table.

Only look at the highest 2 numbers

Another Example of Output

Production Possibilities for Mexico

A B C D E

Avocados 0 20 24 40 60

Soybeans 15 10 9 5 0

Production Possibilities for USA

A B C D E

Avocados 0 30 33 60 90

Soybeans 30 20 19 10 0

Who has the absolute advantage in avocados? The US--US can produce 90 and Mexico only 60.

Who has the absolute advantage in soybeans. The US—US can produce 30 and Mexico only

15.

Another Example of Output

Production Possibilities for Mexico

A B C D E

Avocados 0 20 24 40 60

Soybeans 15 10 9 5 0

Production Possibilities for USA

A B C D E

Avocados 0 30 33 60 90

Soybeans 30 20 19 10 0

Sometimes the problem uses the PPC instead of the table.

Again, look to the highest numbers for each country (person)

Alternative Presentation

5 10 15 20 25 30

15

3

0

45

6

0

75

90

Soybeans

Avo

cad

os

Avocados Soybeans

United States

Mexico

Set up the problem

5 10 15 20 25 30

15

30

45

60

75

90

Soybeans

Avo

cad

os

90 30

60 15

Avocados Soybeans

United States

Mexico

Find the Comparative Advantage

90 30

60 15

1. Find the opportunity cost for each person and task.• Put the opposite number on top and

reduce the fraction. • Opportunity cost to produce 1 avocado=

30 soybeans/90 avocados=1 avocado=1/3 of a soybean

(1/3) (3)

(1/4) (4)

Avocados Soybeans

United States

Mexico

Find the Comparative Advantage

90 30

60 15

(1/3) (3)

(1/4) (4)

Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.

Who has the comparative advantage in avocados?

Look at the avocado columnSee who has the lowest number as the

opportunity cost.

Avocados Soybeans

United States

Mexico

Find the Comparative Advantage

90 30

60 15

(1/3) (3)

(1/4) (4)

Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.

Who has the comparative advantage in avocados?

Look at the avocado columnSee who has the lowest number as the

opportunity cost. The Mexico has the comparative advantage

Avocados Soybeans

United States

Mexico

Find the Comparative Advantage

90 30

60 15

(1/3) (3)

(1/4) (4)

Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.

Who has the comparative advantage in soybeans?

Look at the soybean columnSee who has the lowest number as the

opportunity cost.

Avocados Soybeans

United States

Mexico

Find the Comparative Advantage

90 30

60 15

(1/3) (3)

(1/4) (4)

Step 2: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.

Who has the comparative advantage in soybeans?

Look at the soybean columnSee who has the lowest number as the

opportunity cost.

US will make soybeansExport soybeansImport avocados

Mexico will make avocadosExport avocadosImport soybeans

Importing and Exporting

Avocados Soybeans

United States

Mexico

Terms of Trade

90 30

60 15

(1/3) (3)

(1/4) (4)

• Sometimes problems will ask about what terms of trade (price per good) would be beneficial to both nations.

• For example—In order to be beneficial to both nations what should the terms of trade be for 1 avocado ?

• The easiest thing to do is to look at the column for avocados and place the terms of trade as in between the two numbers. 1 avocado for more than ¼ of a soybean but less than 1/3 of a soybean.

Avocados Soybeans

United States

Mexico

Terms of Trade

90 30

60 15

(1/3) (3)

(1/4) (4)

• What terms of trade would be beneficial to both nations for 1 soybean?

• 1 soybean for 3.5 avocados • Must be more than 3 but less than 4.

• Why?• It costs the US 3 avocados to make a soybean. So they must

sell the soybean at a higher price than they’re cost. • BUT Mexico can make a soybean for 4 avocados. So in order

to benefit, they must pay less than 4 avocados per soybean. • Who would benefit if the terms of trade were 1 soybean for 5

avocados?• US—because they are the sellers and they want at least 3

1. Absolute advantage in wheat?

2. Absolute advantage in TVs?

3. Comparative advantage in wheat?

4. Comparative advantage in TVs?

5. Who would benefit from 1 wheat for 2 tvs?

Wheat TVs

Country A

200 100

Country B

50 50

(1/2) (2)

(1) (1)

1. Absolute advantage in wheat? A2. Absolute advantage in TVs? A3. Comparative advantage in wheat? A4. Comparative advantage in TVs? B5. Who would benefit from 1 wheat for 2 tvs?

A

Not looking at how much the person (country) can produce, but how much resources it takes to produce the same good.

Absolute advantageWho has the lower number?Why? Because it takes him/her less resources.

Comparative advantageSet up the same way EXCEPT switch the order to find the opp. cost

Comparative Advantage—Input Problems

Joe can produce a salad OR a smoothie in only two minutes, but his new trainee Liz takes much longer to produce salads—10 minutes. However, she has worked on her smoothie skills and can turn one out in the same time as Joe.

Who has the absolute advantage in salads? Joe

Who has the absolute advantage in smoothies? Neither

Input ProblemsLiz and Joe at the Smoothie Bar

Salads (production in

minutes)

Smoothies (production in

minutes)

Joe 2 2

Liz 10 2

Instead of putting the opposite number on top. Put the same on top. Joe is the same 2/2.But Liz--To find the opp. cost of producing 1

salad ask yourself, “How many smoothies could she produce in the time that it takes for her to produce 1 salad?”

10/2=5

Input Problems—Liz and Joe

Salads (production in

minutes)

Smoothies (production in

minutes)

Joe 2 2

Liz 10 2

(1) (1)

(5) (1/5)

Assume that: the US can produce a car in 16 minutes; Japan can produce one in 14 minutes; the US can produce a computer in 12 minutes; Japan can produce one in 8 minutes.

1. Which country has the absolute advantage in producing cars?

Japan

2. Absolute advantage in producing computers? Japan

3. Comparative advantage in producing cars?4. Comparative advantage in producing computers?5. Terms of trade advantageous to both?

Input—Cars and Computers in US and Japan

Cars (production in minutes)

Computers (production in minutes)

Japan 14 8

US 16 12

Who is exporting cars?

14/8= 7/4= ( 1 ¾ )

(4/7)

16/12=4/3= ( 1

1/3) ( ¾ )

Winners and Losers of Free Trade

Who wins with free trade according to the theory of comparative advantage?Everyone? Consumers Some ProducersExceptions—dumping, currency manipulation

Who may lose with free trade?Unskilled/ inadaptable labor Society, if unable to deal with problems of

poverty with unemployed unskilled labor

Winners and Losers of Free Trade