CHAPTER 2
Always pick the low-hanging fruit first.©Jason Patrick Ross/Shutterstock
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
1. LO1Explain and apply the Principle of Comparative Advantage and explain how it differs from absolute advantage.
2. LO2Explain and apply the Principle of Increasing Opportunity Cost (also called the Low-Hanging-Fruit Principle). Use a production possibilities curve to illustrate opportunity cost and comparative advantage.
3. LO3Identify factors that shift the menu of production possibilities.
4. LO4Explain the role of comparative advantage in international trade and describe why some jobs are more vulnerable to outsourcing than others.
During a stint as a Peace Corps volunteer in rural Nepal, a young economic naturalist employed a cook named Birkhaman, who came from a remote Himalayan village in neighboring Bhutan. Although Birkhaman had virtually no formal education, he was spectacularly resourceful. His primary duties, to prepare food and maintain the kitchen, he performed extremely well. But he also had other skills. He could thatch a roof, butcher a goat, and repair shoes. An able tinsmith and a good carpenter, he could sew and fix a broken alarm clock, as well as plaster walls. And he was a local authority on home remedies.
Birkhaman’s range of skills was broad even in Nepal, where the least-skilled villager could perform a wide range of services that most Americans hire others to perform. Why this difference in skills and employment?
One might be tempted to answer that the Nepalese are simply too poor to hire others to perform these services. Nepal is indeed a poor country, whose income per person is less than one one-fortieth that of the United States. Few Nepalese have spare cash to spend on outside services. But as reasonable as this poverty explanation may seem, the reverse is actually the case. The Nepalese do not perform their own services because they are poor; rather, they are poor largely because they perform their own services.
The alternative to a system in which everyone is a jack-of-all-trades is one in which people specialize in particular goods and services and then satisfy their needs by trading among themselves. Economic systems based on specialization and the exchange of goods and services are generally far more productive than those with little specialization. Our task in this chapter is to investigate why this is so.
Did this man perform most of his own services because he was poor, or was he poor because he performed most of his own services?Courtesy of Robert H. Frank
As this chapter will show, the reason that specialization is so productive is comparative advantage. Roughly, a person has a comparative advantage at producing a particular good or service (say, haircuts) if that person is relatively more efficient at producing haircuts than at producing other goods or services. We will see that we can all have more of every good and service if each of us specializes in the activities at which we have a comparative advantage.
This chapter also will introduce the production possibilities curve, which is a graphical method of describing the combinations of goods and services that an economy can produce. This tool will allow us to see more clearly how specialization enhances the productive capacity of even the simplest economy.
EXCHANGE AND OPPORTUNITY COST
The Scarcity Principle (see Chapter 1, Thinking Like an Economist) reminds us that the opportunity cost of spending more time on any one activity is having less time available to spend on others. As the following example makes clear, this principle helps explain why everyone can do better by concentrating on those activities at which he or she performs best relative to others.
Scarcity
EXAMPLE 2.1Scarcity Principle
Should Joe Jamail have written his own will?
Joe Jamail was known in the legal profession as “The King of Torts,” the most renowned trial lawyer in American history. And ranked on the Forbes list of the 400 richest Americans, he was also one of the wealthiest, with net assets totaling more than $1.5 billion.
Although Jamail devoted virtually all of his working hours to high-profile litigation, he was also competent to perform a much broader range of legal services. Suppose, for example, that he could have prepared his own will in 2 hours, only half as long as it would take any other attorney. Does that mean that Jamail should have prepared his own will?
Should Joe Jamail have prepared his own will?©Houston Chronicle, Bruce Bennett/AP Images
On the strength of his talent as a litigator, Jamail earned many millions of dollars a year, which meant that the opportunity cost of any time he spent preparing his will would have been several thousand dollars per hour. Attorneys who specialize in property law typically earn far less than that amount. Jamail would have had little difficulty engaging a competent property lawyer who could prepare his will for him for less than $800. So even though Jamail’s considerable skills would have enabled him to perform this task more quickly than another attorney, it would not have been in his interest to prepare his own will.
In Example 2.1, economists would say that Jamail had an absolute advantage at preparing his will but a comparative advantage at trial work. He had an absolute advantage at preparing his will because he could perform that task in less time than a property lawyer could. Even so, the property lawyer has a comparative advantage at preparing wills because her opportunity cost of performing that task is lower than Jamail’s.
Example 2.1 made the implicit assumption that Jamail would have been equally happy to spend an hour preparing his will or preparing for a trial. But suppose he was tired of trial preparation and felt it might be enjoyable to refresh his knowledge of property law. Preparing his own will might then have made perfect sense! But unless he expected to gain extra satisfaction from performing that task, he’d almost certainly do better to hire a property lawyer. The property lawyer would also benefit, or else she wouldn’t have offered to prepare wills for the stated price.
THE PRINCIPLE OF COMPARATIVE ADVANTAGE
One of the most important insights of modern economics is that when two people (or two nations) have different opportunity costs of performing various tasks, they can always increase the total value of available goods and services by trading with one another. The following example captures the logic behind this insight.
EXAMPLE 2.2Comparative Advantage
Should Mary update her own web page?
Consider a small community in which Mary is the only professional bicycle mechanic and Paula is the only professional web designer. If the amount of time each of them to update a web page and repair a bicycle is as shown in Table 2.1, and if each regards the two tasks as equally pleasant (or unpleasant), does the fact that Mary can update a web page faster than Paula imply that Mary should update her own web page?
The entries in the table show that Mary has an absolute advantage over Paula in both activities. While Mary, the mechanic, needs only 20 minutes to update a web page, Paula, the web designer, needs 30 minutes. Mary’s advantage over Paula is even greater when the task is fixing bikes: She can complete a repair in only 10 minutes, compared to Paula’s 30 minutes.
But the fact that Mary is a better web designer than Paula does not imply that Mary should update her own web page. As with the lawyer who litigates instead of preparing his own will, Paula has a comparative advantage over Mary at web design: She is relatively more productive at updating a web page than Mary. Similarly, Mary has a comparative advantage in bicycle repair. (Remember that a person has a comparative advantage at a given task if his or her opportunity cost of performing that task is lower than another person’s.)
What is Paula’s opportunity cost of updating a web page? Because she takes 30 minutes to update each page—the same amount of time she takes to fix a bicycle—her opportunity cost of updating a web page is one bicycle repair. In other words, by taking the time to update a web page, Paula is effectively giving up the opportunity to do one bicycle repair. Mary, in contrast, can complete two bicycle repairs in the time she takes to update a single web page. For her, the opportunity cost of updating a web page is two bicycle repairs. Mary’s opportunity cost to update a web page, measured in terms of bicycle repairs forgone, is twice as high as Paula’s. Thus, Paula has a comparative advantage at web design.
The interesting and important implication of the opportunity cost comparison summarized in Table 2.2 is that the total number of bicycle repairs and web updates accomplished if Paula and Mary both spend part of their time at each activity will always be smaller than the number accomplished if each specializes in the activity in which she has a comparative advantage. Suppose, for example, that people in their community demand a total of 16 web page updates per day. If Mary spent half her time updating web pages and the other half repairing bicycles, an 8-hour workday would yield 12 web page updates and 24 bicycle repairs. To complete the remaining 4 updates, Paula would have to spend 2 hours web designing, which would leave her 6 hours to repair bicycles. And because she takes 30 minutes to do each repair, she would have time to complete 12 of them. So when the two women try to be jacks-of-all-trades, they end up completing a total of 16 web page updates and 36 bicycle repairs.
Consider what would have happened had each woman specialized in her activity of comparative advantage. Paula could have updated 16 web pages on her own and Mary could have performed 48 bicycle repairs. Specialization would have created an additional 12 bicycle repairs out of thin air.
When computing the opportunity cost of one good in terms of another, we must pay close attention to the form in which the productivity information is presented. In Example 2.2, we were told how many minutes each person needed to perform each task. Alternatively, we might be told how many units of each task each person can perform in an hour. Work through the following concept check to see how to proceed when information is presented in this alternative format.
CONCEPT CHECK 2.1
Should Meg update her own web page?
Consider a small community in which Meg is the only professional bicycle mechanic and Pat is the only professional web designer. If their productivity rates at the two tasks are as shown in the table, and if each regards the two tasks as equally pleasant (or unpleasant), does the fact that Meg can update a web page faster than Pat imply that Meg should update her own web page?
The principle illustrated by the preceding examples is so important that we state it formally as one of the core principles of the course:
The Principle of Comparative Advantage: Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.
Comparative Advantage
Indeed, the gains made possible from specialization based on comparative advantage constitute the rationale for market exchange. They explain why each person does not devote 10 percent of his or her time to producing cars, 5 percent to growing food, 25 percent to building housing, 0.0001 percent to performing brain surgery, and so on. By concentrating on those tasks at which we are relatively most productive, together we can produce vastly more than if we all tried to be self-sufficient.
This insight brings us back to Birkhaman the cook. Though Birkhaman’s versatility was marvelous, he was neither as good a doctor as someone who has been trained in medical school, nor as good a repairman as someone who spends each day fixing things. If a number of people with Birkhaman’s native talents had joined together, each of them specializing in one or two tasks, together they would have enjoyed more and better goods and services than each could possibly have produced independently. Although there is much to admire in the resourcefulness of people who have learned through necessity to rely on their own skills, that path is no route to economic prosperity.
Specialization and its effects provide ample grist for the economic naturalist. Here’s an example from the world of sports.
The Economic Naturalist 2.1
Where have all the .400 hitters gone?
In baseball, a .400 hitter is a player who averages at least four hits every 10 times he comes to bat. Though never common in professional baseball, .400 hitters used to appear relatively frequently. Early in the twentieth century, for example, a player known as Wee Willie Keeler batted .432, meaning that he got a hit in over 43 percent of his times at bat. But since Ted Williams of the Boston Red Sox batted .406 in 1941, there hasn’t been a single .400 hitter in the major leagues. Why not?
Some baseball buffs argue that the disappearance of the .400 hitter means today’s baseball players are not as good as yesterday’s. But that claim does not withstand close examination. For example, today’s players are bigger, stronger, and faster than those of Willie Keeler’s day. (Wee Willie himself was just a little over 5 feet 4 inches and weighed only 140 pounds.)
Bill James, a leading analyst of baseball history, argues that the .400 hitter has disappeared because the quality of play in the major leagues has improved, not declined. In particular, pitching and fielding standards are higher, which makes batting .400 more difficult.
Why has no major league baseball player batted .400 since Ted Williams did it more than half a century ago?©Bettmann/Getty Images
Why has the quality of play in baseball improved? Although there are many reasons, including better nutrition, training, and equipment, specialization also has played an important role.1 At one time, pitchers were expected to pitch for the entire game. Now pitching staffs include pitchers who specialize in starting the game (“starters”), others who specialize in pitching two or three innings in the middle of the game (“middle relievers”), and still others who specialize in pitching only the last inning (“closers”). Each of these roles requires different skills and tactics. Pitchers also may specialize in facing left-handed or right-handed batters, in striking batters out, or in getting batters to hit balls on the ground. Similarly, few fielders today play multiple defensive positions; most specialize in only one. Some players specialize in defense (to the detriment of their hitting skills); these “defensive specialists” can be brought in late in the game to protect a lead. Even in managing and coaching, specialization has increased markedly. Relief pitchers now have their own coaches, and statistical specialists use computers to discover the weaknesses of opposing hitters. The net result of these increases in specialization is that even the weakest of today’s teams play highly competent defensive baseball. With no “weaklings” to pick on, hitting .400 over an entire season has become a near-impossible task.
SOURCES OF COMPARATIVE ADVANTAGE
At the individual level, comparative advantage often appears to be the result of inborn talent. For instance, some people seem to be naturally gifted at programming computers while others seem to have a special knack for fixing bikes. But comparative advantage is more often the result of education, training, or experience. Thus, we usually leave the design of kitchens to people with architectural training, the drafting of contracts to people who have studied law, and the teaching of physics to people with advanced degrees in that field.
At the national level, comparative advantage may derive from differences in natural resources or from differences in society or culture. The United States, which has a disproportionate share of the world’s leading research universities, has a comparative advantage in the design of electronic computing hardware and software. Canada, which has one of the world’s highest per-capita endowments of farm and forest land, has a comparative advantage in the production of agricultural products. Topography and climate explain why Colorado specializes in the skiing industry while Hawaii specializes as an ocean resort.
Seemingly noneconomic factors also can give rise to comparative advantage. For instance, the emergence of English as the de facto world language gives English-speaking countries a comparative advantage over non–English-speaking nations in the production of books, movies, and popular music. Even a country’s institutions may affect the likelihood that it will achieve comparative advantage in a particular pursuit. For example, cultures that encourage entrepreneurship will tend to have a comparative advantage in the introduction of new products, whereas those that promote high standards of care and craftsmanship will tend to have a comparative advantage in the production of high-quality variants of established products.
The Economic Naturalist 2.2
What happened to the U.S. lead in the TV and digital video markets?
Televisions and digital video recorders (DVRs) were developed and first produced in the United States, but today the U.S. accounts for only a minuscule share of the total world production of these products. The early lead is explained in part by this country’s comparative advantage in technological research, which in turn was supported by the country’s outstanding system of higher education. Other contributing factors were high expenditures on the development of electronic components for the military and a culture that actively encourages entrepreneurship. As for the production of these products, the United States enjoyed an early advantage partly because the product designs were themselves evolving rapidly at first, which favored production facilities located in close proximity to the product designers. Early production techniques also relied intensively on skilled labor, which is abundant in the United States. In time, however, product designs stabilized and many of the more complex manufacturing operations were automated. Both of these changes gradually led to greater reliance on relatively less-skilled production workers. And at that point, factories located in high-wage countries like the United States could no longer compete with those located in low-wage areas overseas.
Why was the United States unable to remain competitive as a manufacturer of televisions and other electronic equipment?
RECAP
EXCHANGE AND OPPORTUNITY COST
Gains from exchange are possible if trading partners have comparative advantages in producing different goods and services. You have a comparative advantage in producing, say, web pages if your opportunity cost of producing a web page—measured in terms of other production opportunities forgone—is smaller than the corresponding opportunity costs of your trading partners. Maximum production is achieved if each person specializes in producing the good or service in which he or she has the lowest opportunity cost (the Principle of Comparative Advantage). Comparative advantage makes specialization worthwhile even if one trading partner is more productive than others, in absolute terms, in every activity.
COMPARATIVE ADVANTAGE AND PRODUCTION POSSIBILITIES
Comparative advantage and specialization allow an economy to produce more than if each person tries to produce a little of everything. In this section, we gain further insight into the advantages of specialization by introducing a graph that can be used to describe the various combinations of goods and services that an economy can produce.
THE PRODUCTION POSSIBILITIES CURVE
We begin with a hypothetical economy in which only two goods are produced: coffee and pine nuts. It’s a small island economy and “production” consists either of picking coffee beans that grow on small bushes on the island’s central valley floor or of gathering pine nuts that fall from trees on the steep hillsides overlooking the valley. The more time workers spend picking coffee, the less time they have available for gathering nuts. So if people want to drink more coffee, they must make do with a smaller amount of nuts.
If we know how productive workers are at each activity, we can summarize the various combinations of coffee and nuts they can produce each day. This menu of possibilities is known as the production possibilities curve.
To keep matters simple, we begin with an example in which the economy has only a single worker, who can divide her time between the two activities.
EXAMPLE 2.3Production Possibilities Curve
What is the production possibilities curve for an economy in which Susan is the only worker?
Consider a society consisting only of Susan, who allocates her production time between coffee and nuts. She has nimble fingers, a quality that makes her more productive at picking coffee than at gathering nuts. She can gather 2 pounds of nuts or pick 4 pounds of coffee in an hour. If she works a total of 6 hours per day, describe her production possibilities curve—the graph that displays, for each level of nut production, the maximum amount of coffee that she can pick.
The vertical axis in Figure 2.1 shows Susan’s daily production of coffee and the horizontal axis shows her daily production of nuts. Let’s begin by looking at two extreme allocations of her time. First, suppose she employs her entire workday (6 hours) picking coffee. In that case, since she can pick 4 pounds of coffee per hour, she would pick 24 pounds per day of coffee and gather zero pounds of nuts. That combination of coffee and nut production is represented by point A in Figure 2.1. It is the vertical intercept of Susan’s production possibilities curve.
FIGURE 2.1 Susan’s Production Possibilities.For the production relationships given, the production possibilities curve is a straight line.
Now suppose, instead, that Susan devotes all her time to gathering nuts. Since she can gather 2 pounds of nuts per hour, her total daily production would be 12 pounds of nuts. That combination is represented by point D in Figure 2.1, the horizontal intercept of Susan’s production possibilities curve. Because Susan’s production of each good is exactly proportional to the amount of time she devotes to that good, the remaining points along her production possibilities curve will lie on the straight line that joins A and D.
For example, suppose that Susan devotes 4 hours each day to picking coffee and 2 hours to gathering nuts. She will then end up with (4 hours/day) × (4 pounds/hour) = 16 pounds of coffee per day and (2 hours/day) × (2 pounds/hour) = 4 pounds of nuts. This is the point labeled B in Figure 2.1. Alternatively, if she devotes 2 hours to coffee and 4 hours to nuts, she will get (2 hours/day) × (4 pounds/hour) = 8 pounds of coffee per day and (4 hours/day) × (2 pounds/hour) = 8 pounds of nuts. This alternative combination is represented by point C in Figure 2.1.
Because Susan’s production possibilities curve (PPC) is a straight line, its slope is constant. The absolute value of the slope of Susan’s PPC is the ratio of its vertical intercept to its horizontal intercept: (24 pounds of coffee/day)/(12 pounds of nuts/day) = (2 pounds of coffee)/(1 pound of nuts). (Be sure to keep track of the units of measure on each axis when computing this ratio.) This ratio means that Susan’s opportunity cost of an additional pound of nuts is 2 pounds of coffee.
Note that Susan’s opportunity cost (OC) of nuts can also be expressed as the following simple formula:
(2.1)
where “loss in coffee” means the amount of coffee given up and “gain in nuts” means the corresponding increase in nuts. Likewise, Susan’s opportunity cost of coffee is expressed by this formula:
(2.2)
To say that Susan’s opportunity cost of an additional pound of nuts is 2 pounds of coffee is thus equivalent to saying that her opportunity cost of a pound of coffee is ½ pound of nuts.
The downward slope of the production possibilities curve shown in Figure 2.1 illustrates the Scarcity Principle—the idea that because our resources are limited, having more of one good thing generally means having to settle for less of another (see Chapter 1, Thinking Like an Economist). Susan can have an additional pound of coffee if she wishes, but only if she is willing to give up half a pound of nuts. If Susan is the only person in the economy, her opportunity cost of producing a good becomes, in effect, its price. Thus, the price she has to pay for an additional pound of coffee is half a pound of nuts, or the price she has to pay for an additional pound of nuts is 2 pounds of coffee.
Scarcity
Any point that lies either along the production possibilities curve or within it is said to be an attainable point, meaning that it can be produced with currently available resources. In Figure 2.2, for example, points A, B, C, D, and E are attainable points. Points that lie outside the production possibilities curve are said to be unattainable, meaning that they cannot be produced using currently available resources. In Figure 2.2, F is an unattainable point because Susan cannot pick 16 pounds of coffee per day and gather 8 pounds of nuts. Points that lie within the curve are said to be inefficient, in the sense that existing resources would allow for production of more of at least one good without sacrificing the production of any other good. At E, for example, Susan is picking only 8 pounds of coffee per day and gathering 4 pounds of nuts. This means that she could increase her coffee harvest by 8 pounds per day without giving up any nuts (by moving from E to B). Alternatively, Susan could gather as many as 4 additional pounds of nuts each day without giving up any coffee (by moving from E to C). An efficient point is one that lies along the production possibilities curve. At any such point, more of one good can be produced only by producing less of the other.
FIGURE 2.2 Attainable and Efficient Points on Susan’s Production Possibilities Curve.Points that lie either along the production possibilities curve (for example, A, B, C, and D) or within it (for example, E) are said to be attainable. Points that lie outside the production possibilities curve (for example, F) are unattainable. Points that lie along the curve are said to be efficient, while those that lie within the curve are said to be inefficient.
CONCEPT CHECK 2.2
For the PPC shown in Figure 2.2, state whether the following points are attainable and/or efficient:
a. 20 pounds per day of coffee, 4 pounds per day of nuts.
b. 12 pounds per day of coffee, 6 pounds per day of nuts.
c. 4 pounds per day of coffee, 8 pounds per day of nuts.
HOW INDIVIDUAL PRODUCTIVITY AFFECTS THE SLOPE AND POSITION OF THE PPC
To see how the slope and position of the production possibilities curve depend on an individual’s productivity, let’s compare Susan’s PPC to that of Tom’s, who is less productive at picking coffee but more productive at gathering nuts.
EXAMPLE 2.4Productivity Changes
How do changes in productivity affect the opportunity cost of nuts?
Tom is short and has keen eyesight, qualities that make him especially well suited for gathering nuts that fall beneath trees on the hillsides. He can gather 4 pounds of nuts or pick 2 pounds of coffee per hour. If Tom were the only person in the economy, describe the economy’s production possibilities curve.
We can construct Tom’s PPC the same way we did Susan’s. Note first that if Tom devotes an entire workday (6 hours) to coffee picking, he ends up with (6 hours/day) × (2 pounds/hour) = 12 pounds of coffee per day and zero pounds of nuts. So the vertical intercept of Tom’s PPC is A in Figure 2.3. If instead he devotes all his time to gathering nuts, he gets (6 hours/day) × (4 pounds/hour) = 24 pounds of nuts per day and no coffee. That means the horizontal intercept of his PPC is D in Figure 2.3. Because Tom’s production of each good is proportional to the amount of time he devotes to it, the remaining points on his PPC will lie along the straight line that joins these two extreme points.
FIGURE 2.3 Tom’s Production Possibilities Curve.Tom’s opportunity cost of producing 1 pound of nuts is only ½ pound of coffee.
For example, if he devotes 4 hours each day to picking coffee and 2 hours to gathering nuts, he’ll end up with (4 hours/day) × (2 pounds/hour) = 8 pounds of coffee per day and (2 hours/day) × (4 pounds/hour) = 8 pounds of nuts per day. This is the point labeled B in Figure 2.3. Alternatively, if he devotes 2 hours to coffee and 4 hours to nuts, he’ll get (2 hours/day) × (2 pounds/hour) = 4 pounds of coffee per day and (4 hours/day) × (4 pounds/hour) = 16 pounds of nuts. This alternative combination is represented by point C in Figure 2.3.
How does Tom’s PPC compare with Susan’s? Note in Figure 2.4 that because Tom is absolutely less productive than Susan at picking coffee, the vertical intercept of his PPC lies closer to the origin than Susan’s. By the same token, because Susan is absolutely less productive than Tom at gathering nuts, the horizontal intercept of her PPC lies closer to the origin than Tom’s. For Tom, the opportunity cost of an additional pound of nuts is ½ pound of coffee, which is one-fourth Susan’s opportunity cost of nuts. This difference in opportunity costs shows up as a difference in the slopes of their PPCs: The absolute value of the slope of Tom’s PPC is ½, whereas Susan’s is 2.
FIGURE 2.4 Individual Production Possibilities Curves Compared.Tom is less productive in coffee than Susan, but more productive in nuts.
In this example, Tom has both an absolute advantage and a comparative advantage over Susan in gathering nuts. Susan, for her part, has both an absolute advantage and a comparative advantage over Tom in picking coffee.
We cannot emphasize strongly enough that the principle of comparative advantage is a relative concept—one that makes sense only when the productivities of two or more people (or countries) are being compared.
CONCEPT CHECK 2.3
Suppose Susan can pick 2 pounds of coffee per hour or gather 4 pounds of nuts per hour; Tom can pick 1 pound of coffee per hour and gather 1 pound of nuts per hour. What is Susan’s opportunity cost of gathering a pound of nuts? What is Tom’s opportunity cost of gathering a pound of nuts? Where does Susan’s comparative advantage now lie?
THE GAINS FROM SPECIALIZATION AND EXCHANGE
Earlier we saw that a comparative advantage arising from disparities in individual opportunity costs creates gains for everyone (see Examples 2.1 and 2.2). The following example shows how the same point can be illustrated using production possibility curves.
EXAMPLE 2.5Specialization
How costly is failure to specialize?
Suppose that in Example 2.4 Susan and Tom had divided their time so that each person’s output consisted of half nuts and half coffee. How much of each good would Tom and Susan have been able to consume? How much could they have consumed if each had specialized in the activity for which he or she enjoyed a comparative advantage?
Because Tom can produce twice as many pounds of nuts in an hour as pounds of coffee, to produce equal quantities of each, he must spend 2 hours picking coffee for every hour he devotes to gathering nuts. And since he works a 6-hour day, that means spending 2 hours gathering nuts and 4 hours picking coffee. Dividing his time in this way, he’ll end up with 8 pounds of coffee per day and 8 pounds of nuts. Similarly, since Susan can produce twice as many pounds of coffee in an hour as pounds of nuts, to pick equal quantities of each, she must spend 2 hours gathering nuts for every hour she devotes to picking coffee. And because she too works a 6-hour day, that means spending 2 hours picking coffee and 4 hours gathering nuts. So, like Tom, she’ll end up with 8 pounds of coffee per day and 8 pounds of nuts. (See Figure 2.5.) Their combined daily production will thus be 16 pounds of each good. By contrast, had they each specialized in their respective activities of comparative advantage, their combined daily production would have been 24 pounds of each good.
FIGURE 2.5 Production without Specialization.When Tom and Susan divide their time so that each produces the same number of pounds of coffee and nuts, they can consume a total of 16 pounds of coffee and 16 pounds of nuts each day.
If they exchange coffee and nuts with one another, each can consume a combination of the two goods that would have been unattainable if exchange had not been possible. For example, Susan can give Tom 12 pounds of coffee in exchange for 12 pounds of nuts, enabling each to consume 4 pounds per day more of each good than when each produced and consumed alone. Note that point E in Figure 2.5, which has 12 pounds per day of each good, lies beyond each person’s PPC, yet is easily attainable with specialization and exchange.
As the following concept check illustrates, the gains from specialization grow larger as the difference in opportunity costs increases.
CONCEPT CHECK 2.4
How do differences in opportunity cost affect the gains from specialization?
Susan can pick 5 pounds of coffee or gather 1 pound of nuts in an hour. Tom can pick 1 pound of coffee or gather 5 pounds of nuts in an hour. Assuming they again work 6-hour days and want to consume coffee and nuts in equal quantities, by how much will specialization increase their consumption compared to the alternative in which each produced only for his or her own consumption?
Although the gains from specialization and exchange grow with increases in the differences in opportunity costs among trading partners, these differences alone still seem insufficient to account for the enormous differences in living standards between rich and poor countries. Average income in the 20 richest countries in the year 2016, for example, was over $54,000 per person, compared to less than $600 per person in the 20 poorest countries.2 Although we will say more later about specialization’s role in explaining these differences, we first discuss how to construct the PPC for an entire economy and examine how factors other than specialization might cause it to shift outward over time.
A PRODUCTION POSSIBILITIES CURVE FOR A MANY-PERSON ECONOMY
Although most actual economies consist of millions of workers, the process of constructing a production possibilities curve for an economy of that size is really no different from the process for a one-person economy. Consider again an economy in which the only two goods are coffee and nuts, with coffee again on the vertical axis and nuts on the horizontal axis. The vertical intercept of the economy’s PPC is the total amount of coffee that could be picked if all available workers worked full time picking coffee. Thus, the maximum attainable amount of coffee production is shown for the hypothetical economy in Figure 2.6 as 100,000 pounds per day (an amount chosen arbitrarily, for illustrative purposes). The horizontal intercept of the PPC is the amount of nuts that could be gathered if all available workers worked full time gathering nuts, shown for this same economy as 80,000 pounds per day (also an amount chosen arbitrarily). But note that the PPC shown in the diagram is not a straight line—as in the earlier examples involving only a single worker—but rather a curve that is bowed out from the origin.
FIGURE 2.6 Production Possibilities Curve for a Large Economy.For an economy with millions of workers, the PPC typically has a gentle outward bow shape.
We’ll say more in a moment about the reasons for this shape. But first note that a bow-shaped PPC means that the opportunity cost of producing nuts increases as the economy produces more of them. Notice, for example, that when the economy moves from A, where it is producing only coffee, to B, it gets 20,000 pounds of nuts per day by giving up only 5,000 pounds per day of coffee. When nut production is increased still further, however—for example, by moving from B to C—the economy again gives up 5,000 pounds per day of coffee, yet this time gets only 10,000 additional pounds of nuts. This pattern of increasing opportunity cost persists over the entire length of the PPC. For example, note that in moving from D to E, the economy again gives up 5,000 pounds per day of coffee but now gains only 2,000 pounds a day of nuts. Note, finally, that the same pattern of increasing opportunity cost applies to coffee. Thus, as more coffee is produced, the opportunity cost of producing additional coffee—as measured by the amount of nuts that must be sacrificed—also rises.
Why is the PPC for the multiperson economy bow shaped? The answer lies in the fact that some resources are relatively well suited for gathering nuts while others are relatively well suited for picking coffee. If the economy is initially producing only coffee and wants to begin producing some nuts, which workers will it reassign? Recall Susan and Tom, the two workers discussed in the preceding example, in which Tom’s comparative advantage was gathering nuts and Susan’s comparative advantage was picking coffee. If both workers were currently picking coffee and you wanted to reassign one of them to gather nuts instead, whom would you send? Tom would be the clear choice because his departure would cost the economy only half as much coffee as Susan’s and would augment nut production by twice as much.
The principle is the same in any large multiperson economy, except that the range of opportunity cost differences across workers is even greater than in the earlier two-worker example. As we keep reassigning workers from coffee production to nut production, sooner or later we must withdraw even coffee specialists like Susan from coffee production. Indeed, we must eventually reassign others whose opportunity cost of producing nuts is far higher than hers.
The shape of the production possibilities curve shown in Figure 2.6 illustrates the general principle that when resources have different opportunity costs, we should always exploit the resource with the lowest opportunity cost first. We call this the Low-Hanging-Fruit Principle, in honor of the fruit picker’s rule of picking the most accessible fruit first:
Increasing Opportunity Cost
The Principle of Increasing Opportunity Cost (also called the “Low-Hanging-Fruit Principle”): In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs.
A NOTE ON THE LOGIC OF THE FRUIT PICKER’S RULE
Why should a fruit picker harvest the low-hanging fruit first? This rule makes sense for several reasons. For one, the low-hanging fruit is easier (and hence cheaper) to pick, and if he planned on picking only a limited amount of fruit to begin with, he would clearly come out ahead by avoiding the less-accessible fruit on the higher branches. But even if he planned on picking all the fruit on the tree, he would do better to start with the lower branches first because this would enable him to enjoy the revenue from the sale of the fruit sooner.
The fruit picker’s job can be likened to the task confronting a new CEO who has been hired to reform an inefficient, ailing company. The CEO has limited time and attention, so it makes sense to focus first on problems that are relatively easy to correct and whose elimination will provide the biggest improvements in performance—the low-hanging fruit. Later on, the CEO can worry about the many smaller improvements needed to raise the company from very good to excellent.
Again, the important message of the Low-Hanging-Fruit Principle is to be sure to take advantage of your most favorable opportunities first.
RECAP
COMPARATIVE ADVANTAGE AND PRODUCTION POSSIBILITIES
For an economy that produces two goods, the production possibilities curve describes the maximum amount of one good that can be produced for every possible level of production of the other good. Attainable points are those that lie on or within the curve and efficient points are those that lie along the curve. The slope of the production possibilities curve tells us the opportunity cost of producing an additional unit of the good measured along the horizontal axis. The Principle of Increasing Opportunity Cost, or the Low-Hanging-Fruit Principle, tells us that the slope of the production possibilities curve becomes steeper as we move downward to the right. The greater the differences among individual opportunity costs, the more bow-shaped the production possibilities curve will be; and the more bow-shaped the production possibilities curve, the greater the potential gains from specialization will be.
FACTORS THAT SHIFT THE ECONOMY’S PRODUCTION POSSIBILITIES CURVE
As its name implies, the production possibilities curve provides a summary of the production options open to any society. At any given moment, the PPC confronts society with a trade-off. The only way people can produce and consume more nuts is to produce and consume less coffee. In the long run, however, it is often possible to increase production of all goods. This is what is meant when people speak of economic growth. As shown in Figure 2.7, economic growth is an outward shift in the economy’s production possibilities curve. It can result from increases in the amount of productive resources available or from improvements in knowledge or technology that render existing resources more productive.
FIGURE 2.7 Economic Growth: An Outward Shift in the Economy’s PPC.Increases in productive resources (such as labor and capital equipment) or improvements in knowledge and technology cause the PPC to shift outward. They are the main factors that drive economic growth.
What causes the quantity of productive resources to grow in an economy? One factor is investment in new factories and equipment. When workers have more and better equipment to work with, their productivity increases, often dramatically. This is surely an important factor behind the differences in living standards between rich and poor countries. According to one study, for example, the value of capital investment per worker in the United States is about 30 times as great as in Nepal.3
Such large differences in capital per worker don’t occur all at once. They are a consequence of decades, even centuries, of differences in rates of savings and investment. Over time, even small differences in rates of investment can translate into extremely large differences in the amount of capital equipment available to each worker. Differences of this sort are often self-reinforcing: Not only do higher rates of saving and investment cause incomes to grow, but the resulting higher income levels also make it easier to devote additional resources to savings and investment. Over time, then, even small initial productivity advantages from specialization can translate into very large income gaps.
Population growth also causes an economy’s PPC curve to shift outward and thus is often listed as one of the sources of economic growth. But because population growth also generates more mouths to feed, it cannot by itself raise a country’s standard of living. Indeed it may even cause a decline in the standard of living if existing population densities have already begun to put pressure on available land, water, and other resources.
Perhaps the most important sources of economic growth are improvements in knowledge and technology. As economists have long recognized, such improvements often lead to higher output through increased specialization. Improvements in technology often occur spontaneously. More frequently they are directly or indirectly the result of increases in education.
Earlier we discussed a two-person example in which individual differences in opportunity cost led to a tripling of output from specialization (Concept Check 2.4). Real-world gains from specialization often are far more spectacular than those in the example. One reason is that specialization not only capitalizes on preexisting differences in individual skills but also deepens those skills through practice and experience. Moreover, it eliminates many of the switching and start-up costs people incur when they move back and forth among numerous tasks. These gains apply not only to people but also to the tools and equipment they use. Breaking a task down into simple steps, each of which can be performed by a different machine, greatly multiplies the productivity of individual workers.
Even in simple settings, these factors can combine to increase productivity hundreds- or even thousands-fold. Adam Smith, the Scottish philosopher who is remembered today as the founder of modern economics, was the first to recognize the enormity of the gains made possible by the division and specialization of labor. Consider, for instance, his description of work in an eighteenth-century Scottish pin factory:
One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations . . . I have seen a small manufactory of this kind where only ten men were employed . . . [who] could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day.4
The gains in productivity that result from specialization are indeed often prodigious. They constitute the single most important explanation for why societies that don’t rely heavily on specialization and exchange have failed to keep pace.
WHY HAVE SOME COUNTRIES BEEN SLOW TO SPECIALIZE?
You may be asking yourself, “If specialization is such a great thing, why don’t people in poor countries like Nepal just specialize?” If so, you’re in good company. Adam Smith spent many years attempting to answer precisely the same question. In the end, his explanation was that population density is an important precondition for specialization. Smith, ever the economic naturalist, observed that work tended to be far more specialized in the large cities of England in the eighteenth century than in the rural Highlands of Scotland:
In the lone houses and very small villages which are scattered about in so desert a country as the Highlands of Scotland, every farmer must be butcher, baker, and brewer for his own family. . . . A country carpenter . . . is not only a carpenter, but a joiner, a cabinet maker, and even a carver in wood, as well as a wheelwright, a ploughwright, a cart and waggon maker.5
In contrast, each of these same tasks was performed by a different specialist in the large English and Scottish cities of Smith’s day. Scottish Highlanders also would have specialized had they been able to, but the markets in which they participated were simply too small and fragmented. Of course, high population density by itself provides no guarantee that specialization will result in rapid economic growth. But especially before the arrival of modern shipping and electronic communications technology, low population density was a definite obstacle to gains from specialization.
Nepal remains one of the most remote and isolated countries on the planet. As recently as the mid-1960s, its average population density was less than 30 people per square mile (as compared, for example, to more than 1,000 people per square mile in New Jersey). Specialization was further limited by Nepal’s rugged terrain. Exchanging goods and services with residents of other villages was difficult, because the nearest village in most cases could be reached only after trekking several hours, or even days, over treacherous Himalayan trails. More than any other factor, this extreme isolation accounts for Nepal’s long-standing failure to benefit from widespread specialization.
Population density is by no means the only important factor that influences the degree of specialization. Specialization may be severely impeded, for example, by laws and customs that limit people’s freedom to transact freely with one another. The communist governments of North Korea and the former East Germany restricted exchange severely, which helps explain why those countries achieved far less specialization than South Korea and the former West Germany, whose governments were far more supportive of exchange.
CAN WE HAVE TOO MUCH SPECIALIZATION?
Of course, the mere fact that specialization boosts productivity does not mean that more specialization is always better than less, for specialization also entails costs. For example, most people appear to enjoy variety in the work they do, yet variety tends to be one of the first casualties as workplace tasks become ever more narrowly specialized.
Indeed, one of Karl Marx’s central themes was that the fragmentation of workplace tasks often exacts a heavy psychological toll on workers. Thus, he wrote,
All means for the development of production . . . mutilate the laborer into a fragment of a man, degrade him to the level of an appendage of a machine, destroy every remnant of charm in his work and turn it into hated toil.6
Charlie Chaplin’s 1936 film Modern Times paints a vivid portrait of the psychological costs of repetitive factory work. As an assembly worker, Chaplin’s only task, all day every day, is to tighten the nuts on two bolts as they pass before him on the assembly line. Finally, he snaps and staggers from the factory, wrenches in hand, tightening every nutlike protuberance he encounters.
Do the extra goods made possible by specialization simply come at too high a price? We must certainly acknowledge at least the potential for specialization to proceed too far. Yet specialization need not entail rigidly segmented, mind-numbingly repetitive work. And it is important to recognize that failure to specialize entails costs as well. Those who don’t specialize must accept low wages or work extremely long hours.
When all is said and done, we can expect to meet life’s financial obligations in the shortest time—thereby freeing up more time to do whatever else we wish—if we concentrate at least a significant proportion of our efforts on those tasks for which we have a comparative advantage.
COMPARATIVE ADVANTAGE AND INTERNATIONAL TRADE
The same logic that leads the individuals in an economy to specialize and exchange goods with one another also leads nations to specialize and trade among themselves. As with individuals, each nation can benefit from exchange, even though one may be generally more productive than the other in absolute terms.
The Economic Naturalist 2.3
If trade between nations is so beneficial, why are free-trade agreements so controversial?
One of the most heated issues in the 1996 presidential campaign was President Clinton’s support for the North American Free Trade Agreement (NAFTA), a treaty to sharply reduce trade barriers between the United States and its immediate neighbors north and south. The treaty attracted fierce opposition from third-party candidate Ross Perot, who insisted that it would mean unemployment for millions of American workers. If exchange is so beneficial, why does anyone oppose it?
If free trade is so great, why do so many people oppose it?
The answer is that, while reducing barriers to international trade increases the total value of all goods and services produced in each nation, it does not guarantee that each individual citizen will do better. One specific concern regarding NAFTA was that it would help Mexico to exploit a comparative advantage in the production of goods made by unskilled labor. Although U.S. consumers would benefit from reduced prices for such goods, many Americans feared that unskilled workers in the United States would lose their jobs to workers in Mexico.
In the end, NAFTA was enacted over the vociferous opposition of American labor unions. So far, however, studies have failed to detect significant overall job losses among unskilled workers in the United States, although there have been some losses in specific industries.
OUTSOURCING
An issue very much in the news in recent years has been the outsourcing of U.S. service jobs. Although the term once primarily meant having services performed by subcontractors anywhere outside the confines of the firm, increasingly it connotes the act of replacing relatively expensive American service workers with much cheaper service workers in overseas locations.
A case in point is the transcription of medical records. In an effort to maintain accurate records, many physicians dictate their case notes for later transcription after examining their patients. In the past, transcription was often performed by the physician’s secretary in spare moments. But secretaries also must attend to a variety of other tasks that disrupt concentration. They must answer phones, serve as receptionists, prepare correspondence, and so on. As insurance disputes and malpractice litigation became more frequent during the 1980s and 1990s, errors in medical records became much more costly to physicians. In response, many turned to independent companies that offered transcription services by full-time, dedicated specialists.
These companies typically served physicians whose practices were located in the same community. But while many of the companies that manage transcription services are still located in the United States, an increasing fraction of the actual work itself is now performed outside the United States. For example, Eight Crossings, a company headquartered in northern California, enables physicians to upload voice dictation files securely to the Internet, whereupon they are transmitted to transcribers who perform the work in India. The finished documents are then transmitted back, in electronic form, to physicians, who may edit and even sign them online. The advantage for physicians, of course, is that the fee for this service is much lower than for the same service performed domestically because wage rates in India are much lower than in the United States.
In China, Korea, Indonesia, India, and elsewhere, even highly skilled professionals still earn just a small fraction of what their counterparts in the United States are paid. Accordingly, companies face powerful competitive pressure to import not just low-cost goods from overseas suppliers, but also a growing array of professional services.
As Microsoft Chairman Bill Gates put it in a 1999 interview,
As a business manager, you need to take a hard look at your core competencies. Revisit the areas of your company that aren’t directly involved in those competencies, and consider whether Web technologies can enable you to spin off those tasks. Let another company take over the management responsibilities for that work, and use modern communication technology to work closely with the people—now partners instead of employees are doing the work. In the Web work style, employees can push the freedom the Web provides to its limits.7
In economic terms, the outsourcing of services to low-wage foreign workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers. In both cases, the resulting cost savings benefit consumers in the United States. And in both cases, jobs in the United States may be put in jeopardy, at least temporarily. An American manufacturing worker’s job is at risk if it is possible to import the good he produces from another country at lower cost. By the same token, an American service worker’s job is at risk if a lower-paid worker can perform that same service somewhere else.
The Economic Naturalist 2.4
Is PBS economics reporter Paul Solman’s job a likely candidate for outsourcing?
Paul Solman and his associate Lee Koromvokis produce video segments that provide in-depth analysis of current economic issues for the PBS evening news program PBS NewsHour. Is it likely that his job will someday be outsourced to a low-wage reporter from Hyderabad, India?
In the book The New Division of Labor, economists Frank Levy and Richard Murnane attempt to identify the characteristics of a job that make it a likely candidate for outsourcing.8 In their view, any job that is amenable to computerization is also vulnerable to outsourcing. To computerize a task means to break it down into units that can be managed with simple rules. ATM machines, for example, were able to replace many of the tasks that bank tellers once performed because it was straightforward to reduce these tasks to a simple series of questions that a machine could answer. By the same token, the workers in offshore call centers who increasingly book our airline and hotel reservations are basically following simple scripts much like computer programs.
So the less rules-based a job is, the less vulnerable to outsourcing it is. Safest of all are those that Levy and Murnane describe as “face-to-face” jobs. Unlike most rules-based jobs, these jobs tend to involve complex face-to-face communication with other people, precisely the kind of communication that dominates Solman’s economics reporting.
In an interview for PBS NewsHour, Solman asked Levy what he meant, exactly, by “complex communication.”
“Suppose I say the word bill,” Levy responded, “and you hear that. And the question is what does that mean? . . . Am I talking about a piece of currency? Am I talking about a piece of legislation, the front end of a duck? The only way you’re going to answer that is to think about the whole context of the conversation. But that’s very complicated work to break down into some kind of software.”9
Levy and Murnane describe a second category of tasks that are less vulnerable to outsourcing—namely, those that for one reason or another require the worker to be physically present. For example, it is difficult to see how someone in China or India could build an addition to someone’s house in a Chicago suburb or repair a blown head gasket on someone’s Chevrolet Corvette in Atlanta or fill a cavity in someone’s tooth in Los Angeles.
So on both counts, Paul Solman’s job appears safe for the time being. Because it involves face-to-face, complex communication, and because many of his interviews can be conducted only in the United States, it is difficult to see how a reporter from Hyderabad could displace him.
Of course, the fact that a job is relatively safe does not mean that it is completely sheltered. For example, although most dentists continue to think themselves immune from outsourcing, it is now possible for someone requiring extensive dental work to have the work done in New Delhi and still save enough to cover his airfare and a two-week vacation in India.
There are more than 160 million Americans in the labor force. Each year, almost 20 percent of workers leave their jobs and a roughly equal number find new ones.10 At various points in your life, you are likely to be among this group in transition. In the long run, the greatest security available to you or any other worker is the ability to adapt quickly to new circumstances. Having a good education provides no guarantee against losing your job, but it should enable you to develop a comparative advantage at the kinds of tasks that require more than just executing a simple set of rules.
RECAP
COMPARATIVE ADVANTAGE AND INTERNATIONAL TRADE
Nations, like individuals, can benefit from exchange, even though one trading partner may be more productive than the other in absolute terms. The greater the difference between domestic opportunity costs and world opportunity costs, the more a nation benefits from exchange with other nations. But expansions of exchange do not guarantee that each individual citizen will do better. In particular, unskilled workers in high-wage countries may be hurt in the short run by the reduction of barriers to trade with low-wage nations.
SUMMARY
· One person has an absolute advantage over another in the production of a good if she can produce more of that good than the other person. One person has a comparative advantage over another in the production of a good if she is relatively more efficient than the other person at producing that good, meaning that her opportunity cost of producing it is lower than her counterpart’s. Specialization based on comparative advantage is the basis for economic exchange. When each person specializes in the task at which he or she is relatively most efficient, the economic pie is maximized, making possible the largest slice for everyone. (LO1)
· At the individual level, comparative advantage may spring from differences in talent or ability or from differences in education, training, and experience. At the national level, sources of comparative advantage include those innate and learned differences, as well as differences in language, culture, institutions, climate, natural resources, and a host of other factors. (LO1)
· The production possibilities curve is a simple device for summarizing the possible combinations of output that a society can produce if it employs its resources efficiently. In a simple economy that produces only coffee and nuts, the PPC shows the maximum quantity of coffee production (vertical axis) possible at each level of nut production (horizontal axis). The slope of the PPC at any point represents the opportunity cost of nuts at that point, expressed in pounds of coffee. (LO2)
· All production possibilities curves slope downward because of the Scarcity Principle, which states that the only way a consumer can get more of one good is to settle for less of another. In economies whose workers have different opportunity costs of producing each good, the slope of the PPC becomes steeper as consumers move downward along the curve. This change in slope illustrates the Principle of Increasing Opportunity Cost (or the Low-Hanging-Fruit Principle), which states that in expanding the production of any good, a society should first employ those resources that are relatively efficient at producing that good, only afterward turning to those that are less efficient. (LO2)
· Factors that cause a country’s PPC to shift outward over time include investment in new factories and equipment, population growth, and improvements in knowledge and technology. (LO3)
· The same logic that prompts individuals to specialize in their production and exchange goods with one another also leads nations to specialize and trade with one another. On both levels, each trading partner can benefit from an exchange, even though one may be more productive than the other, in absolute terms, for each good. For both individuals and nations, the benefits of exchange tend to be larger the larger the differences are between the trading partners’ opportunity costs. (LO4)
CORE PRINCIPLES
Comparative Advantage
The Principle of Comparative Advantage
Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.
Increasing Opportunity Cost
The Principle of Increasing Opportunity Cost (also called the “Low-Hanging-Fruit Principle”)
In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs.
KEY TERMS
absolute advantage
attainable point
comparative advantage
efficient point
inefficient point
outsourcing
production possibilities curve
unattainable point
REVIEW QUESTIONS
1. 1.Explain what “having a comparative advantage” at producing a particular good or service means. What does “having an absolute advantage” at producing a good or service mean? (LO1)
2. 2.What factors have helped the United States to become the world’s leading exporter of movies, books, and popular music? (LO1)
3. 3.Why does saying that people are poor because they do not specialize make more sense than saying that people perform their own services because they are poor? (LO2, LO3)
4. 4.How will a reduction in the number of hours worked each day affect an economy’s production possibilities curve? (LO3)
5. 5.How will technological innovations that boost labor productivity affect an economy’s production possibilities curve? (LO3)
PROBLEMS
1. 1.Ted can wax a car in 20 minutes or wash a car in 60 minutes. Tom can wax a car in 15 minutes or wash a car in 30 minutes. What is each man’s opportunity cost of washing a car? Who has a comparative advantage in washing cars? (LO1)
2. 2.Ted can wax 4 cars per day or wash 12 cars. Tom can wax 3 cars per day or wash 6 cars. What is each man’s opportunity cost of washing a car? Who has a comparative advantage in washing cars? (LO1)
3. 3.Nancy and Bill are auto mechanics. Nancy takes 4 hours to replace a clutch and 2 hours to replace a set of brakes. Bill takes 6 hours to replace a clutch and 2 hours to replace a set of brakes. State whether anyone has an absolute advantage at either task and, for each task, identify who has a comparative advantage. (LO1)
4. 4.Consider a society consisting only of Helen, who allocates her time between sewing dresses and baking bread. Each hour she devotes to sewing dresses yields 4 dresses and each hour she devotes to baking bread yields 8 loaves of bread. (LO2)
a. If Helen works a total of 8 hours per day, graph her production possibilities curve.
b. Using your graph, which of the points listed below are attainable and/or efficient?
28 dresses per day, 16 loaves per day.
16 dresses per day, 32 loaves per day.
18 dresses per day, 24 loaves per day.
5. 5.Suppose that in Problem 4 a sewing machine is introduced that enables Helen to sew 8 dresses per hour rather than only 4. (LO3)
a. Show how this development shifts her production possibilities curve.
b. Indicate if the following points are attainable and/or efficient before and after the introduction of the sewing machine.
16 dresses per day, 48 loaves per day.
24 dresses per day, 16 loaves per day.
c. Explain what is meant by the following statement: “An increase in productivity with respect to any one good increases our options for producing and consuming all other goods.”
6. 6.Susan can pick 4 pounds of coffee beans in an hour or gather 2 pounds of nuts. Tom can pick 2 pounds of coffee beans in an hour or gather 4 pounds of nuts. Each works 6 hours per day. (LO2, LO3)
a. Together, what is the maximum number of pounds of coffee beans the two can pick in a day? What is the maximum number of pounds of nuts the two can gather in a day?
b. Now suppose Susan and Tom were gathering the maximum number of pounds of nuts when they decided that they would like to begin picking 8 pounds of coffee per day. Who would pick the coffee, and how many pounds of nuts would they still be able to gather?
c. Would it be possible for Susan and Tom in total to gather 26 pounds of nuts and pick 20 pounds of coffee each day? If so, how much of each good should each person pick?
d. Is the point at 30 pounds of coffee per day, 12 pounds of nuts per day an attainable point? Is it an efficient point?
e. On a graph with pounds of coffee per day on the vertical axis and pounds of nuts per day on the horizontal axis, show all the points you identified in parts a–d.
7. 7.* Refer to the two-person economy described in Problem 6. (LO2, LO3)
a. Suppose that Susan and Tom could buy or sell coffee and nuts in the world market at a price of $2 per pound for coffee and $2 per pound for nuts. If each person specialized completely in the good for which he or she had a comparative advantage, how much could they earn by selling all they produce?
b. At the prices just described, what is the maximum amount of coffee Susan and Tom could buy in the world market with the income they earned? What is the maximum amount of nuts? Would it be possible for them to consume 40 pounds of nuts and 8 pounds of coffee each day?
c. In light of their ability to buy and sell in world markets at the stated prices, show on the same graph all combinations of the two goods it would be possible for them to consume.
ANSWERS TO CONCEPT CHECKS
1. 2.1
The entries in the table tell us that Meg has an absolute advantage over Pat in both activities. While Meg, the mechanic, can update 3 web pages per hour, Pat, the web designer, can update only 2. Meg’s absolute advantage over Pat is even greater in the task of fixing bikes—3 repairs per hour versus Pat’s 1.
But as in the second example in this chapter, the fact that Meg is a better web designer than Pat does not imply that Meg should update her own web page. Meg’s opportunity cost of updating a web page is 1 bicycle repair, whereas Pat must give up only half a repair to update a web page. Pat has a comparative advantage over Meg at web design and Meg has a comparative advantage over Pat at bicycle repair. (LO1)
2. 2.2In the accompanying graph, A (20 pounds per day of coffee, 4 pounds per day of nuts) is unattainable; B (12 pounds per day of coffee, 6 pounds per day of nuts) is both attainable and efficient; and C (4 pounds per day of coffee, 8 pounds per day of nuts) is attainable and inefficient. (LO2)
3. 2.3Susan’s opportunity cost of gathering a pound of nuts is now ½ pound of coffee and Tom’s opportunity cost of gathering a pound of nuts is now only 1 pound of coffee. So Tom has a comparative advantage at picking coffee and Susan has a comparative advantage at gathering nuts. (LO2)
4. 2.4Because Tom can produce five times as many pounds of nuts in an hour as pounds of coffee, to produce equal quantities of each, he must spend 5 hours picking coffee for every hour he devotes to gathering nuts. And because he works a 6-hour day, that means spending 5 hours picking coffee and 1 hour gathering nuts. Dividing his time in this way, he will end up with 5 pounds of each good. Similarly, if she is to produce equal quantities of each good, Susan must spend 5 hours gathering nuts and 1 hour picking coffee. So she, too, produces 5 pounds of each good if she divides her 6-hour day in this way. Their combined daily production will thus be 10 pounds of each good. By working together and specializing, however, they can produce and consume a total of 30 pounds per day of each good. (LO2)
1For an interesting discussion of specialization and the decline of the .400 hitter from the perspective of an evolutionary biologist, see Stephen Jay Gould, Full House (New York: Three Rivers Press, 1996), part 3.
2The 20 richest countries tracked by the International Monetary Fund: Australia, Austria, Belgium, Canada, Denmark, Finland, Germany, Iceland, Ireland, Japan, Luxembourg, Netherlands, Norway, Qatar, San Marino, Singapore, Sweden, Switzerland, United Kingdom, and United States. The 20 poorest countries tracked by the International Monetary Fund: Afghanistan, Burkina Faso, Burundi, Central African Republic, Comoros, Democratic Republic of the Congo, Guinea, Guinea-Bassau, Liberia, Madagascar, Malawi, Mozambique, Nepal, Niger, Rwanda, Sierra Leone, South Sudan, The Gambia, Togo, and Uganda. (Source: IMF World Economic Outlook Database, April 2017, www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx).
3Alan Heston and Robert Summers, “The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950–1988,” Quarterly Journal of Economics, May 1991, pp. 327–68.
4Smith, Adam, The Wealth of Nations. New York, NY: Everyman’s Library, Book 1, 1910.
5Smith, Adam, The Wealth of Nations. New York, NY: Everyman’s Library, Book 1, 1910.
6Marx, Karl, Das Kapital. New York, NY: Modern Library, 1906, 708, 709.
7Source: Gates, Bill, Business @ The Speed of Thought: Using a Digital Nervous System. New York, NY: Warner Books, March 1999.
8Frank Levy and Richard Murnane, The New Division of Labor: How Computers Are Creating the Next Job Market (Princeton, NJ: Princeton University Press, 2004).
9www.pbs.org/newshour/bb/business-july-dec04-jobs_8-16/
10www.compensationforce.com/2017/04/2016-turnover-rates-by-industry.html
*Denotes more difficult problem.