ECON1101: Macroeconomics 1

Chapter 2: Comparative
advantage
Absolute advantage vs. comparative advantage
Absolute advantage is when someone can undertake an action with fewer
resources than others.
Comparative advantage is when someones opportunity cost of undertaking
an action is lower than that of others.

The principle of comparative advantage

The principle of comparative advantage states that everyone one is better
off if they specialise on their comparative advantage.

Sources of individual
comparative advantage

Talent
Education and raining
Experience

Sources of national comparative

advantage

Natural resources
Technology
Infrastructure
Climate (e.g. for tourism)
Culture (e.g. entrepreneurial
spirit)

Production possibilities curve (PPC)

The production possibilities curve (PPC) shows the maximum amount of one
good that can be produced for every possible level of production of another
good.

An attainable point lies on or below the PPC.

An unattainable point lies above the PPC.
An efficient point lies on the PPC.

An inefficient point lies below the PPC.

Slope

The slope of the PPC is equal to the opportunity cost of the good on the xaxis.

If there are two PPCs, the steeper one has a comparative advantage in
producing the good on the y-axis, and the flatter one has a comparative
advantage in producing the good on the x-axis.

Specialisation

Specialisation allows for consumption beyond the PPCs (unless the PPCs
are the same).

Terms of trade

The opportunity costs set the bounds of the terms of trade.

The PPC for a many-person economy

The PPC For a many-person economy usually has an outwardly-bowed shape
because of the principle of increasing opportunity cost.

The principle of increasing opportunity cost

The principle of increasing opportunity cost (or the low-hanging
fruit principle) states that, in expanding the production of any good, first
employ those resources with the lowest opportunity cost.

Factors that shift an economys PPC

Population growth
Capital equipment
Knowledge
Technology

Costs of specialisation

Psychological costs of repetitive work

Dependence on other countries for certain goods
Specialisation maximises aggregate gains, but may cause inequality.

Barriers to specialisation

Low population density

Laws and customs
A lack of well-developed markets