Productivity, Wages, and Trade

Comparative Advantage

Comparative advantage is the ability to produce an item at a lower opportunity cost. In Musica or Sportica, for example, the cost of producing a basketball is the number of CDs given up. Resources are scarce, so the workers of each country can produce more of one item only by taking resources away from producing the other. When Musica's workers produce a basketball, for instance, they use 2 hours of scarce labor. Those 2 hours could have been used in CD production, producing 2 CDs. This means that the cost of producing a basketball in Musica is 2 CDs.

What is the cost of producing a basketball in Sportica? Its workers use 3 hours for making a basketball, which is half the time required to make a CD and comparatively less than the cost of producing a basketball in Musica. Indeed, Sportica has a comparative advantage in basketball production even though Sportica requires more time to produce a basketball than Musica.

Which country has a comparative advantage in CDs? Musica's cost of a CD is only half of a basketball. Similarly. Sportica's cost of a CD is 2 basketballs. In this instance, then, Musica has a comparative advantage in CDs because its cost of producing CDs is lower.

It shows that Musica has a comparative advantage in CD production and Sportica has a comparative advantage in basketball production. Based on their comparative advantages, the two nations can gain by trading with one another. Musica can get a basketball from Sportica instead of producing one itself. And Sportica can get a CD from Musica instead of making the CD itself. After the exchange each nation still gets 1 CD and 1 basketball, but people in both countries are using their resources more efficiently.

Musica gets both products, but its workers now spend only 2 hours rather than the 3 hours shown in Figure 15-3. Sportica also gets both products, but its workers now spend only 6 hours instead of 9. Each county has gained because both have traded according to comparative advantage. As a result, the people of each nation can now enjoy a higher standard of living.

Productivity, Wages, and Trade

By using the imaginary example of Musica and Sportica, you can understand the role of productivity in trade. Musica is more productive in both products because of its absolute advantages. Despite Musica's superior productivity in basketball production, it gains by producing CDs instead. So it isn't the level of productivity (absolute advantage) that determines the gains of specialization and trade; rather, it's Musica's productivity in basketball production compared with its productivity in CD production. Comparing Musica's productivity in both products yields a comparative advantage only in CD production. Similarly, comparing Sportica's productivity in both products yields a comparative advantage in basketballs—despite its lower productivity in making either product.

This last sentence deserves special emphasis. Sportica can still gain from trade even though it is less productive in making both products. Not many years ago, many poorer nations in the world worried that they would be unable to compete with wealthier nations whose productivity was so much higher. People in these nations often argued that the more productive workers in wealthier nations would take jobs away from less productive workers in their nations. Economists explained, however, that countries could still compete and gain from trade even if they were less productive at making every possible product. Just like Sportica, they would have a comparative advantage in some things.

We hear a similar fear expressed about trade in the United States today. But now the worry isn't about more productive workers abroad; it's about the ability of our higher-paid workers to compete successfully with lower-paid workers in other nations. Economists point out, however, that the main reason for the higher pay of U.S. workers is their higher productivity. They can produce more, usually because of many years of investments that have produced a cupboard full of capital resources, education, skills, knowledge, and work values.

Take Musica and Sportica as an illustration. Suppose the average wage is $15 per hour in Musica but only $5 per hour in Sportica. Will Musica's CD workers lose their jobs? They won't, and the reason is that Musica's higher wage is supported by its higher productivity. The numbers in the box show that the cost per CD is still lower in Musica than in Sportica because workers are sufficiently productive to support the higher wage.

This discussion points out the importance of maintaining a high level of productivity in our economy. Productivity and Labor, productivity determines our wages and standard of living. Suppose U.S. workers are generally four times as productive as workers in another country where wage rates are much lower. This means the average U.S. wage can be at most four times higher without making the labor cost of a product higher here.

In contrast, the productivity of some U.S. businesses and industries will be less than four times higher. The inferior productivity of these businesses can't compensate for the higher wages they must pay U.S. workers. These producers have a comparative disadvantage and are likely to shrink, pay lower wages, and lay off workers.

Date: 2015-12-24; view: 894