Transcription
Hey econ students, this is Jacob Clifford in your AP or introductory college-level economics class. Unit 1 concepts are the easiest to learn. You learn about scarcity and opportunity cost. The production possibilities curve and economic systems are all easy, except for one thing. For a lot of students, it's the hardest thing in the entire class. It's when you learn about trade and you have to identify comparative advantage and calculate terms of trade. So here are five hacks for comparative advantage that you definitely need to know.
Hack number one is spotting output and input questions. If your teacher or professor gave you one of these two tables, you might think, "Well, they're exactly the same." For the United States, it's five and one, and for China, it's three and two. It's the same, but these are completely different because this one is an output question, and this one is an input question. These numbers represent the number of cars or planes that can be produced in one hour. But these numbers represent the number of hours it takes to produce only one car or one plane. This is an output question because it's showing you the number of stuff that can be produced in a given amount of time. This is an input question because it's looking at the resources to produce a specific amount of output.
So here's the hack: If you look at a table and you realize that you want higher numbers, you want to produce more cars, more planes, it's an output question. It's better to produce five cars than only three cars. And so the United States has an absolute advantage in the production of cars. But when you're looking at input questions, you want lower numbers. You want fewer hours or less land or less capital to produce a certain amount of goods. So in this case, China has an absolute advantage in cars because it only takes them three hours to produce one car, where it takes the United States five hours to produce one car. You want lower numbers. Input question.
Hack number two: OOO and IOU. Now, the next step in these comparative advantage questions is calculating the per-unit opportunity cost. In other words, how much does each one car cost the United States in terms of planes given up? Now, this is where students get confused. Like, "Okay, one car either costs one-fifth of a plane or is it five planes?" They get confused, and they mess themselves up. If they get it wrong, they're done. So here's the hack: For output questions, I want you to remember OOO: Other goes over. So if you're calculating the opportunity cost of a car, you take the number of planes and put it over the number of cars. So in this case, one over five. Each car costs one-fifth of a plane, and that means that each one plane costs five cars. And you can do this for China. So for each one of these cars, it costs them two-thirds of a plane, and each plane costs three halves of a car. Again, it's an output question, so the other goes over.
Now, it's not the same for input questions. For input questions, you're using IOU: Input, other goes under. For the U.S., the opportunity cost of producing each one of those cars is five planes, and each plane costs one-fifth of a car. And for China, each car costs three halves of a plane, and each plane costs two-thirds of a car. So when it comes to calculating the per-unit opportunity cost, just remember OOO for output questions and IOU for input questions.
Hack number three: It's basically a 50/50. When you've got to this point, you've done all the calculations. Now you have to figure out who has the comparative advantage in cars and planes. Now, just remember, it won't be the United States for both of them. It's either one or the other. In other words, the United States is going to have a comparative advantage in either cars or planes, not cars and planes. So there are only two possible answers here: either the United States should specialize in cars and China should do the planes, or the United States should specialize in the planes and China should do the cars. So even if you don't know how to do any of these calculations, it's still just a 50/50, so you can just guess. But to get the right answer, you don't need to guess. Just choose the one that has the lower opportunity cost. In this case, the United States should specialize in cars, and China specialize in planes. This is because the U.S. produces cars at a lower opportunity cost than China, and China produces planes at a lower opportunity cost than the U.S. And by the way, it's the same idea for an input question. You do the same exact thing. Choose the lower opportunity cost. In this case, the United States should specialize in the planes, and China to specialize in the cars.
Okay, hack number four is finding the terms of trade. Conceptually, this is a really easy idea. Countries or individuals only trade that benefits themselves, and there's a mutually beneficial exchange that has to take place. And there's no reason for me to trade with you unless I can get the product that you're selling at a lower opportunity cost than I can produce it myself. So the concept is easy, but the hard part is calculating the exact number of units you have to trade. One car for a certain number of planes. So here's how you do it. First of all, we know the United States is going to specialize in cars, which means they want planes. And if the United States produces planes on their own, it's going to cost them five cars. So the terms of trade have to be less than five. If it's more than five, it costs them ten cars to get one plane, they're like, "Ah, I'll just make it myself." So for the United States, the terms of trade for one plane has to be less than five cars. So we know that trading one plane for four cars is beneficial for the United States. Let's see if that's true for China. You know they're going to specialize in planes and they want cars. And if they decide to produce cars on their own, it's going to cost two-thirds of a plane given up. So for China, the terms of trade for one car has to be less than two-thirds of a plane. Let's go back and look at the terms of trade that we thought might work, which was one plane for four cars. And that's the same as one car for one-fourth of a plane. Now, since one-fourth is less than two-thirds, this is beneficial for China. China wants this terms of trade that will work for them. If they decide to trade, then China can get those cars for a lower opportunity cost than if they produce themselves, and the United States can get those planes for lower opportunity costs than if they produce those planes themselves. So one plane for four cars, the terms of trade that is mutually beneficial.
Here's the hack: When you've got the chart all set up like this, one plane for any number between five cars and three halves of a car benefits both countries. Any number between those two numbers will work. And if you look at the other side, that works too. One car for any number between one-fifth of a plane and two-thirds of a plane would work for both countries. And that is how you do terms of trade.
Okay, hack number five, it's time to show you the quick and dirty. So I do a lot of workshops with teachers, and years ago, I'm explaining comparative advantage up on the board, and then the teacher raises their hand and says, "Hey, have you ever done the quick and dirty?" And I was like, "Uh, no, that's super weird." But he says, "No, I'm talking about comparative advantage," and he gets up and he shows me the trick I'm about to show you, which is super quick and super dirty. So basically, it's just a quick way to get comparative advantage without having to do all that work. But make sure you understand how to do that work, and you can do the calculations to find terms of trade.
Okay, here's the quick and dirty. Remember when we're looking at comparative advantage, either the United States should specialize in the cars or they should specialize in the planes, one or the other. So if you multiply the numbers that show you the possible outcomes, 5 times 2 is 10, or 3 times 1 is 3. Pick the higher number. That tells you the right outcome and who should specialize in what. That shows you who has a comparative advantage. Super dirty, right? Obviously, this doesn't show you anything. You can just multiply two numbers to get the right answer, but it works every single time. But remember, you don't add, you multiply. And let's go to it for an input question. 5 times 2 is 10. 3 times 1 is 3. In this case, you choose the lower number that shows who has a comparative advantage with an input question. Now that you know this hack, you can find comparative advantage super quick. For example, if I gave you new numbers without doing any calculations, super fast, use the quick and dirty, figure out who should specialize in what. Ready? Go. So this is an output question. 4 times 10 is 40. 2 times 12 is 24. You want the higher number, 40 is more. That's who has a comparative advantage.
Okay, that was five hacks that you definitely need to know for comparative advantage. Now it's time to practice. I made a separate video for you that has you practice these. I give you four different scenarios. And if you want even more practice, you want to support my YouTube channel, take a look at my ultimate review packet. If you're a teacher, take a look at my economics worksheets. The links are all in the description below. Thanks for watching. Until next time.