How to figure out who has the comparative advantage. - FreeEconHelp.com, Learning Economics... Solved!

6/22/18

How to figure out who has the comparative advantage.

Shortly after you learn about opportunity costs and PPFs, you will need to learn about gains from trade and comparative advantage. The trick to figuring out who has the comparative advantage in which good is to be able to calculate opportunity costs quickly and reliably. You will probably be given a table that shows the different possible levels of output a certain individual is able to produce (of two goods or services). You can use this information to calculate the tradeoffs (or opportunity costs) associated with the different possible levels of production. Once you have the opportunity cost calculated, you can compare that result to the opportunity cost the other country or individual has for the good to see which opportunity cost is lower. The individual or country with the lowest opportunity has the comparative advantage. Below, I go through two examples, one with individuals and another with countries.




John


Linda


Tacos
Apples

Tacos
Apples
A
0
3

0
30
B
5
2

2
20
C
10
1

4
10
D
15
0

6
0

Using the information above, we could sketch a PPF for both John and Linda, but in this situation we do not need to do that. Instead, we will only calculate the opportunity cost for Tacos for both individuals. Once we do this, we can figure out who has the comparative advantage and then move on to the next problem--probably figuring out how to gain from trade.

So first we should focus on the trade-off between tacos and apples for John. We can see that for every apple John produces he has to give up 5 tacos (give 5 tacos for each apple-->5/1) visit this post for more info on calculating opportunity cost or see the video below). When we do the same sort of analysis for Linda we see that she that she gives up 0.2 tacos for every apple she gets (give 2 tacos for 10 apples-->2/10) . This means that Linda has the comparative advantage in apple production because her opportunity cost of 0.2 tacos is less than Johns opportunity cost of 5 tacos. Similarly, we can see that John has the comparative advantage in taco production because he gives up less apples to produce a taco than Linda does.


America


Australia


Corn
Kiwis

Corn
Kiwis
A
0
3

0
40
B
10
2

2
30
C
20
1

4
15
D
30
0

6
0

In the second example, we can see that the only real thing that has changed or the names at the top of the table and the numbers below. Whether we are dealing with countries or individuals, the process of figuring out who has comparative advantage will be the same. This means that we need to calculate the opportunity cost again for each good before we figure out who has the comparative advantage.


Looking at Australia, we can see that the opportunity cost of 1 unit of corn is 5 kiwis (they get 2 corn for every 10 units of kiwis that they give up--10/2), and that the opportunity cost of producing 1 unit of corn will be 0.1 kiwis (they get 10 corn for every kiwi that they give up-->1/10). This means that America has the lower opportunity cost in corn production and therefore has the comparative advantage in corn. If we repeat the process for Australia we see that they have the lower opportunity cost in kiwi production so they will have the comparative advantage in producing kiwis.

Again, the trick to figuring out who has the comparative advantage in which good or service is to calculate the opportunity cost for each good or service among the two people or countries being included in the problem. Also, remember not to confuse comparative advantage with absolute advantage. Comparative advantage means that one person or country has the lowest opportunity cost in production while absolute advantage means that they can produce more given the same inputs. It IS possible for one person or country to have the absolute advantage in both goods but it is NOT possible for an individual or country to have the comparative advantage in both goods.


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