Comparative Advantage Homework

Make sure you’ve completed the homework introduced in the Comparative Advantage video before you watch this video, as we’ll be going over the answer. We take a look at our example which compares shirt and computer production and consumption in Mexico and the United States. At the end of this video, you’ll have a better understanding of why it makes sense for countries to engage in trade. - See more at: http://mruniversity.com/courses/principles-economics-microeconomics/comparative-advantage-trade-homework?

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♪ [music] ♪

- [Alex Tabarrok] In this talk
I'm going to give you the answer

to the homework question,
so before you begin,

make sure you've done
your homework.

No cheating.

So remember our basic data
is in the top figure right here,

and we want to now answer

supposing that
there's 24 units of labor --

12 devoted to computers,
12 to shirts --

how many computers
and shirts in Mexico?

How many in the United States?

Okay, well if Mexico devotes
12 units of labor

to producing computers
and it takes 12 units of labor

to produce one computer,

then you're going to get
one computer.

In Mexico it takes
two units of labor

to produce one shirt,

so if you devote 12 units of labor
to shirt production

you're going to get six shirts.

United States is even easier
because it just takes

one unit of labor
to get one computer,

one unit of labor to get one shirt.

Therefore, if you devote
12 units of labor to computers,

you get 12 computers,

and if you devote
12 units of labor to shirts,

you get 12 shirts.

So the total world production
of computers is 13 computers,

and total world production
of shirts is 18 shirts.

Okay, now let's suppose that

Mexico specializes,
puts all of its labor,

24 units of labor,
into shirt production

and zero into computer production.

How many shirts and computers now?
Well, clearly zero computers.

Shirts: we now have 12 shirts,
24 units of labor,

2 units of labor per shirts,
so you get 12 shirts in total.

What about the United States,
which now devotes

14 units of labor to computers,
10 to shirts.

Again, because it's one unit
of labor per computer,

one unit of labor per shirt,
then we simply get 14 and 10.

Now here's the key,
look at the totals.

We now have 14 computers,
okay, and 22 shirts.

So total world production
is going up.

We have more computers
with specialization

than we did when the two countries

were not specialized
and did not trade.

Here we have 13 and 18.

Now we've got 14 and 22,
a big increase.

Now notice how, however,

that Mexico doesn't have
many computers.

And the United States has
fewer shirts than they did before.

So is there a way
to make both countries better off?

Well, clearly since

the total production
has gone up there is.

Let's take a look at how to do that.

Here again is consumption
with no trade.

Here is production
with specialization.

Now suppose that the United States

trades one computer
to get three shirts.

There are
other possible trades which make both

countries better off, but this is a nice
simple one. So the United States trades

one computer - remember it produced 14 - it
trades one computer to Mexico, so United

States now has 13, it gives one to Mexico,
and Mexico has one in return for three

shirts so the United States used to have
10 shirts now it gets 13. Those extra

three shirts come from Mexico which
produce 12 but now Mexico only consumes 9.

So now let's take a look. Total production
is the same, okay, but notice what has

happened to consumption with
specialization and trade compared to when

there was no trade. So when there was no
trade, Mexico consumes 1 computer and 6

shirts, now they're consuming 1 computer
and 9 shirts. So Mexico is better off by

three shirts. The United States was
consuming 12 computers and 12 shirts, now

they're consuming 13 of each so they're
better off.

The United States is better off by one
computer and better off by one shirt.

Pretty remarkable. Trade according to
Comparative Advantage has made both

countries better off. One thing to keep in
mind here is that Absolute Advantage,

although it doesn't explain trade, it does
explain how wealthy countries are. So even

with trade, notice that Mexico is still
considerably less wealthy than the United

States, that is, total production of Mexico
is one computer and nine shirts compared to

the United States with 13 computers and 13
shirts. So Absolute Advantage does explain

which countries in the world are rich or
one of the aspects of which countries in

the world are rich. But Comparative
Advantage explains why it makes sense to

trade and what goods it make sense to trade,
and for more on this I invite you to take

a look at my textbook with Tyler, Modern
Principles of Economics. Thanks.

If you want to test yourself click
Practice Questions,

or if you're ready to
move on just click Next Video.