Exploring how comparative advantage provides the basis, and incentive, for trade.

Comparative advantage is perhaps the single most powerful force in economic relationships. The idea that if we each do that for which we have the lowest cost we can all benefit, in terms of things forgone, is the basis for nearly all economic activity. As a simple household example, we all understand that the best cook should do the cooking, while the best at cleaning should do the cleaning up; but what if one individual is best at both? In this case the one who gives up the most cooking to do a particular amount of cleaning should clean. We do this instinctively when left to our own devices, but when it comes to larger groups, both regional and national, it is very easy to lose sight of this simple relationship.

Exploration: How does opportunity cost drive trade, and how does trade improve human welfare?

Tom and Susan (the individuals in this simple two-person economy) produce coffee and nuts. The interactive graph describes Tom and Susan's current productivity (per hour) of these two goods (note that numbers are different than those used in the textbook), while the graphs illustrate their associated individual and combined production possibility frontiers, assuming that each individual works a maximum of 8 hours per day and splits his/her time equally between coffee and nut production.

1. According to the information in the graph, what is the opportunity cost of coffee for Tom and Susan? What is the opportunity cost of nuts for Tom and Susan? How are these calculated?
   
   
2. Who has a comparative advantage in coffee production? Who has a comparative advantage in nut production? Which good should each person specialize in to boost overall production in the economy?
   
   
3. Initially, each person spends half the day picking coffee and half the day picking nuts. What happens to total production of coffee and nuts in this economy if each person spends the entire day producing the good that he/she has a comparative advantage in? To see the effects of this reallocation of labor hours, change the Coffee Labor Hours values for Tom and Susan in the table above (the Nuts Labor Hours value will change automatically) and see what happens to New Production. What happens to overall production in this economy?
   
   
   
4. From the response to question 3, what do you conclude about the benefits of specialization?
   
   

Exploration: How does changing productivity affect comparative advantage and the gains from specialization?

As the level of productivity changes in an economy, the mix of activities very well may change with it. The relationship depends on whether the change in productivity is economy-wide (such as the introduction of a new type of power generation in an industrial economy or a new type of hybridization or fertilization in an agrarian economy) or specialized to a particular activity (such as a new way of casting steel for dental tools or a new type of picker for oranges).

Reset the tables and graphs to their original values by clicking on the Reset button.

1. Now let's assume that Susan and Tom get trained in new picking techniques that allow them to dramatically increase their overall picking productivity for coffee while having no impact on their ability to pick nuts. To illustrate this, increase each of the coffee productivity numbers in the table by 10% (i.e. Tom's coffee production rises to 55 pounds per hour and Susan's coffee production rises to 22 pounds per hour while nut production per hour stays at the original levels). What happens to the individual production possibility curves?
   
   
2. After the increase in economy-wide productivity, who has a comparative advantage in coffee production?
   
   
3. Who has a comparative advantage in nut production?
   
   
4. Which good should each person specialize in?
   
   
5. What happens to overall production in the economy after specialization?
   
   

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