Consider the following questions:
Should a country produce everything it wants? Why or Why not?
If Country A is better than Country B at producing everything, would Country A gain anything by trading with Country B?
- When a new home is built, why doesn't one person do the carpentry, electrical, plumbing, and landscaping?
We will consider these questions again after considering an interesting example involving LeBron James.
In this lesson, you will apply the concepts of opportunity costs, absolute and comparative advantage, as well as provide examples, to LeBron James mowing his own lawn scenario. Next, you will use data to assess the gains available through trade and specialization, followed by identifying and utilizing the concepts presented in the LeBron James scenario to real world examples. Lastly, you will apply the concepts presented to international trade, including imports and exports.
Here are some terms you need to know:
Opportunity Cost The value of the next best alternative. For example, the opportunity cost of studying on Friday night might be missing your high school team's football game. Why would LeBron James chose not to attend college and play college basketball? An economist would answer this question by stating that the opportunity cost of college (making millions in the NBA) was too high for James.
Comparative Advantage The ability to produce something at a lower opportunity cost than other producers.
Law of Comparative Advantage : An individual, firm, region or country with the lowest opportunity cost of producing a good should specialize in that good.
Absolute Advantage The ability to produce something using fewer resources than other producers.
Now that you have an understanding of these terms you can apply them using an interesting example using NBA star LeBron James.
Assume LeBron is both a great basketball player and a great lawn mower. However, LeBron has a young neighbor named Scotty who is willing to mow his lawn. Consider the following facts:
LeBron can mow his lawn in two hours. He could also film a Nike commercial in two hours and make $10,000. So, what is James' opportunity cost of mowing his lawn?
Neighbor Scotty can mow LeBron's lawn in four hours. He could also work at McDonald's for four hours and make $8 per hour. So, what is Scotty's opportunity cost of mowing the lawn?
Who has an absolute advantage in mowing the lawn?
Who has comparative advantage in mowing the lawn?
Would LeBron benefit from a trade?
We can apply this to many real world examples. This analysis suggests that we should specialize in what we are good at and trade with others for other things we want. Can you think of any examples that utilize this type of thinking?
Let's now re-visit the questions we considered before this lesson. Use the note-taker provided below to type and print your answers.
1. Should a country produce everything it wants? Why or Why not?
2. If Country A is better than Country B at producing everything, would Country A gain anything by trading with Country B?
3. When a new home is built, why doesn't one contractor do everything: carpentry, electrical, plumbing and landscaping?
This lesson demonstrates that LeBron James should specialize in the area that he has a comparative advantage (lower opportunity cost), as should Scotty. It also shows that James has an absolute advantage in both activities-- that is, he can do them both using less resources. In both examples, the resources are the same (time) and money is used to measure them. In the end, the gains from trade are tremendous-- both James and Scotty are much better off if the trade is made.
After you have taken this interactive quiz, you should print off your answers and submit them.
1. If Britain has a comparative advantage over France in the production of cars, then...
A. the opportunity cost of producing cars in Britain is lower than in France.
B. the opportunity cost of producing cars in Britain is higher than in France.
C. there are no gains from specialization and trade in cars between Britain and France.
D. only Britain will gain from specialization and trade in cars between Britain and France.
2. If people specialize in producing those goods for which they possess a comparative advantage, then the economy as a whole can produce a greater quantity of goods.
3. The law of comparative advantage says that a person should produce a good if he or she...
a. has the greatest desire to consume that good
b. has the lowest opportunity cost of producing that good
c. has an absolute advantage in a related activity
d. has a comparative advantage in a related activity
e. is equally good at producing this good as someone else is
4. John takes 10 minutes to iron a shirt and 20 minutes to type a paper. Harry takes 10 minutes to iron a shirt and 30 minutes to type a paper. Which of the following statements is correct?
a. Harry has a comparative advantage in ironing.
b. Harry has a comparative advantage in typing.
c. Harry has an absolute advantage in typing.
d. Harry has an absolute advantage in ironing.
e. Neither can gain from specialization and exchange.
1. Brainstorm some goods and services in which the United States likely has a comparative advantage. Next, make a list of some goods and services the United States likely has a disadvantage in producing. What nations would have a comparative advantage in these goods or services?
*Note: Data from the Bureau of Economic Analysis may be useful to you.
2. Research the U.S.'s major trading partners. Who are the major trading partners of the United States? What goods does the U.S. import and what goods does the U.S. export? Does the U.S. gain from trading with other nations? Why?
-The U.S. Census Bureau has monthly data on Top Trading Partners: May, 2010 , Suite101 lists the Top US Imports & Exports 2009 , and Wolfram Demonstrations Project shows and explains why the U.S. Gains from Trade .