The Law of Comparative Advantage (C)

Example (1):
Output Table
Country A B
Sneakers 6 4
Basket Balls 8 4

Answer:
 B has an absolute disadvantage in the production of both commodities with
respect to the A
 A has an absolute advantage in the production of both commodities with respect
to B
 According to Adam Smith theory of Absolute Advantage, trade cannot take place.
Calculating Opportunity Cost
For A
 6S = 8B
1S = 1.3B
1B = 0.75S
For B
 4S = 4B
1S = 1B
1B = 1S
Specialization and Trade
 A has a comparative advantage and would specialize in producing Basket Balls
because it has lower opportunity cost (0.75S) than B (1S)
 B has a comparative advantage and would specialize in producing Sneakers
because it has lower opportunity cost (1B) than A (1.3B)
Trade Range
𝟔𝑺 < 𝟖𝑩 < 𝟖𝑺
Trade Terms and Gains
Suppose the A exchanges 8B for 7S with the B
 A gains 1S (or saves 1/6 hour) since it could only exchange 8B for 6S domestically.
 B gains 1B (or saves 1/4 hour) since it could only exchange 7S for 7B domestically.
So, both countries A, and B gain from trade

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Example (2):
Assume that both the United States and Germany produce beef and computer chips with the
following costs:
Country United States (Dollars) Germany (Marks)
Unit cost of beef (B) 2 8
Unit cost of computer chips (C) 1 2

a. In which commodity does the United States and Germany has an absolute
advantage?
b. What is the opportunity cost of beef (B) and computer chips (C) in each country?
c. In which commodity does the United States have a comparative cost advantage?
What about Germany?
d. What is the range for mutually beneficial trade between the United States and
Germany for each computer chip traded?
e. How much would the United States and Germany gain if 1 unit of beef is exchanged
for 3 chips?

Answer:
a. United States has an absolute advantage in producing both commodities (lower
cost)
Germany has absolute disadvantage in producing both commodities (higher cost)

b. In the United States:

 The opportunity cost of one unit of beef is 2 chips;
 The opportunity cost of one chip is 1/2 unit of beef.
In Germany:
 The opportunity cost of one unit of beef is 4 chips;
 The opportunity cost of one chip is 1/4 unit of beef.
c. The United States has a comparative cost advantage in beef with respect to
Germany,
While Germany has a comparative cost advantage in computer chips.

d. The range for mutually beneficial trade between the United States and Germany
for each unit of beef that the United States exports is:
2C < 1B < 4C

e. US gains 1C (or saves 1$) since it could only exchange 1B for 2C domestically
Germany gains 0.25B (or saves 2 Marks) since it could only exchange 3C for 0.75B
domestically.

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