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?

Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics

Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/comparative-advantage-trade-homework#QandA

Next video: http://mruniversity.com/courses/principles-economics-microeconomics/tariffs-quotas-protectionism-definition

♪ [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

suppose 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,

two 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 nine.

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 one computer and six

shirts, now they're consuming
one computer and nine 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."

♪ [music] ♪