Comparative
Advantage
Or why trade is good
Absolute vs. Comparative
Advantage
Absolute - better in every possible way
being considered
Comparative - better at a single task or
is the least worst at a certain task, taking
opportunity cost into consideration
Comparative Advantage
Cheat Sheet
Input method to determine comparative
advantage
If problem sets up comparison based on
amount of time, resources or any other
inputs used, determine opportunity cost
of X by dividing amount country uses to
make X by amount country uses to make
Y
Example # 1
USA produces a car in 16 minutes.
Japan produces a car in 14 minutes.
USA produces a computer in 12
minutes, Japan in 8 minutes.
Opportunity cost of USA to produce
cars is 16 ÷12 = 1 1/3 computers for
every car made.
Who should make cars? Computers?
Cars vs. Computers
Opportunity cost for USA making cars is 1 ⅓
computers
Opportunity cost for Japan making cars is 1 ¾
computers
( 14 ÷ 8 = 1 ¾)
USA should make cars
Opportunity cost for USA making computers is
12 ÷ 16 = ¾ car
Opportunity cost for Japan making computers is
8 ÷ 14 = 4/7 car
Japan should make computers
Example # 2 Output Method
If problem sets up comparison based on
amount produced, determine opportunity
cost of X by dividing amount country
produces of X into amount country
produces of Y.
USA produces 33 toy cars per hour,
China 36. USA produces 44 dolls per
hour, China 72.
Who should produce toy cars, dolls?
Toy cars vs. Dolls
Opportunity cost for China making toy cars is
72 ÷ 36 = 2 dolls
Opportunity cost for USA making toy cars is 44
÷ 33 = 1 ⅓ dolls
USA should make toy cars
Opportunity cost for China making dolls is 36 ÷
72 = ½ toy car
Opportunity cost for USA making dolls is 33 ÷
44 = ¾ toy car
China should make dolls
Assume both Italy and
Greece only produce wine
and olive oil. It Italy hold a
comparative advantage in
wine production, which of
the following statements is
NOT true?
a) Italy must hold an
absolute advantage in the
production of wine.
b) Greece holds a
comparative advantage in
the production of olive oil.
c) Italy’s opportunity cost of
producing one additional
unit of wine is lower than
Greece’s.
d) Greece’s opportunity cost
of producing one additional
unit of olive oil is lower than
Italy’s.
e) If trade is open between
them, these countries have
an incentive to trade.
Correct answer is (a)
Italy doesn’t have to have an absolute
advantage in order to have a
comparative advantage. Remember Kim
and Kanye…it takes her longer to do
everything.
Italy only has to have less of a sacrifice
when making wine than Greece.
Read more about comparative
advantage
See additional comparative
advantage/trade problems - questions 1
through 6 at the end of chapter 38 on
page 863 of the McConnell textbook.
Suppose that Sam
can knit 5 sweaters
or make 4 blankets in
one week and Dave
can make 10
sweaters or 6
blankets in one
week. Which is true?
a) Sam has an
absolute advantage
when making
blankets.
b) Sam has an absolute
advantage when knitting
sweaters.
c) Sam has a comparative
advantage in blanketmaking.
d) Sam has a comparative
advantage in sweaterknitting.
e) Sam has neither a
comparative advantage in
making blankets or
sweaters.
Correct answer is c)
Sam has a comparative advantage in
making blankets
Sam OC blankets 5/4 (1 ¼), OC
sweaters 4/5
Rob OC blankets 10/6 (1 2/3), OC
sweaters 6/10 (3/5)
1 ¼ less than 1 2/3 for blankets.
Also, Dave has comparative advantage
for sweaters 3/5 less than 4/5
A has both absolute and
comparative advantage in
manufactured goods.
A has an absolute advantage
in manufactured goods but a
comparative advantage in
service goods.
B has a comparative
advantage in service goods
but no absolute advantage in
either good.
A has a absolute advantage in
service goods but a
comparative advantage in
manufactured goods.
B has an absolute advantage
in manufactured goods, but
without more info,
comparative advantage can’t
be determined.
Correct answer is b)
A can make 100 manufactured goods to
B’s 75 for an absolute advantage
However, A has 1/3 manufactured good
given up to make service goods to B’s ½
so has a a comparative advantage
making service goods.
Trade and Specialization Expand
Production Possibilities
Specialization
People doing specialized tasks
Limited by the extent of the market
People and regions / countries tend to
specialize in activities where they have a
comparative advantage (lower
opportunity cost)
By specializing, more of each good is
produced, rather than everyone
spending equal time producing less
Gains from Trade (Exchange)
Voluntary exchange is mutually beneficial
Exchange / economic activity is a positive-sum
game, not a zero-sum game at the time of the
trade
Gains from trade are mutual, but not
necessarily equal
Assumes reasonably good information
regarding the trade by buyers & sellers (No
fraud, misrepresentation, etc.)
Ignores disruption problems e.g. people losing
jobs due to items being made more cheaply
overseas.
Kanye v. Kim
Kanye is better at both mowing and cooking but
should he do both?
No. Whatever task he has the lower opportunity
cost for, that is what he should do and then
trade with Kim
Kanye has an absolute advantage at cooking
and mowing, but a comparative advantage for
cooking. Kim’s opportunity cost for mowing is
less than Kanye’s, so she should trade lawn
mowing.