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

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.

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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, okay. 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.

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