R (Lab minutes per unit of F (Lab minutes per unit of

output) output)
Meat Potato Meat Potato
20 (I M) 10 (1 P) 60 (1 M) 15 (1 P)
30 75
1.5 M – 1M = 0.5 M 5 P – 1P =4 P
Terms of trade = 1:1 Import 1P Import 1 M
Gain -0.5 M +3P
Terms of trade =between 2 and 1.5 M – 0.3 M = 1.2 M 5 P -3P = 2P
4 = 3 , 1:3 Gain 0.2 M Gain 1 P

R has an absolute advantage in the production

of both commodities.
F has an absolute disadvantage in the
production of both commodities .
According to the Law of Comparative
Advantage, even if one nation is less efficient
than other nation in the production of both
commodities, there is still a basis for mutually
beneficial trade by applying comparative
advantage , that is less opportunity cost in the
production.
Opportunity Cost
Rancher

M 20 P 10

P 10/20 = 0.5 M =1/2 M

M 20/10 = 2P

1 M = 2P

Farmer

M 60 P 15

1 P 15/60 = 0.25 M = ¼ M

1 M = 60/15 = 4 P

Opportunity Cost (Labor Unit)

R F
Meat Potato Meat Potato

2P 0.5 M 4P 0.25 M

Opportunity cost of Meat 1 oz of meat is equal to 2Potata and 1 oz of Potato is equal to 0.5 of Meat in
Rancher’s production.

Opportunity cost of Meat 1 oz of meat is equal to 4 Potato and 1 oz of Potato is equal to 0.25 of Meat in
Farmer’s production.

Rancher has a comparative advantage in the production of Meat while F has a comparative advantage in
Potato production.

R must specialize in the production of Meat, and export Meat, and then import Potato from Farmer.

F must specialize in the production of Potato, and export Potato, and then import Meat from Rancher.

If Terms of Trade is 1:1, Rancher will lose (-0.5M) and Farmer will gain (4P).

Rancher does not agree the TOT 1:1. R & F has agreed the terms of trade between 2 and 4., that is 1:3.

If TOT is 1:3, R will gain 0.2 M while F will gain 1P.

Therefore, both R & F will get gain from trade by using comparative advantage theory.
Value added products => Product differentiation