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001 Comparative Vs Absolute Advantage
001 Comparative Vs Absolute Advantage
Absolute
Advantage
Students will be able to understand the difference between absolute and comparative advantage (in
theory and graphically), calculate opportunity cost of two nations production of the same 2 goods, and
determine terms of international trade
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Absolute vs. Comparative
Advantage
Absolute Advantage:
Either: A) a individual/firm/country can can produce more of a good with the
same input as another country
B) Can produce a certain output using a fewer amount of resources as another
(mainly illustrated in terms of time)
LEBRON HAS ABSOLUTE ADVANTAGE IN MOWING HIS LAWN!
Comparative Advantage:
Whoever can produce a good with a lower opportunity cost!!!
More influential in production than absolute advantage!
FELIX HAS COMPARATIVE ADVANTAGE IN MOWING LEBRON”S LAWN!
Result of Specialization
Why don’t we all make our own houses, grow/gather our own
food, heal our own wounds?
Trade
Issue to resolve: Does it pay for the U.S to trade with China?
Why Comparative Advantage is
Key
Told about what resources are needed to produce one unit of a good in order to
calculate opportunity cost.
“…required to produce…”
“…per hour…”
Given final data on the amount of a good that can be produced with
a given amount of input to calculate opportunity cost.
After specialization, assume the two countries agree to trade 20 billion bushels of wheat for
7.5 billion T-shirts. Are the outcomes going to be an improvement for both countries?
In our example from yesterday,
U.S.: 1 shirt costs 4 bushels of wheat—1 wheat costs ¼ shirt
China: 1 shirt costs 2 bushels of wheat –1 wheat costs ½ shirt
So,
the price at which China and the U.S are willing to trade T-shirts must fall between China’s
opportunity cost for producing T-shirts and U.S.’s opportunity cost for producing T-shirts.
China is the country that specializes in T-shirts, and it cannot charge a price greater than the
U.S.’s opportunity cost.
Conversely, China must receive a price that covers its opportunity costs for making T-shirts,
or it will not be willing to trade.
Terms of Trade
From our original example: US producing 200 wheat and 50 shirts, while China
produces 50 wheat and 25 shirts…
US opportunity costs: 1 wheat costs ¼ shirt—1 shirt costs 4 wheat
China opportunity cost: 1 wheat costs ½ shirt—1 shirt costs 2 wheat; therefore,
USA (wheat): before trade, the opportunity cost of making a T-shirt in the U.S
was 4 bushels of wheat. Thus USA has no incentive to trade unless USA can get
1 T-shirt from China for less than 4 bushels of their wheat production
Thus the mutually beneficial terms of trade for 1 T-shirt (1T) is: