Comparative Advantage

What the Economy Does

Basic questions
What?
How?
For Whom?

Resource categories
Land natural resources limited in quantity
Labor-Human power
Capital-created resources
Entrepreneurial talent-business skills

Comparative Advantage &

the Production Possibilities Frontier
Absolute Advantage
Ability to produce at less cost

Comparative Advantage
Relative Ability to produce at less cost
Based upon Opportunity Cost (whats given
up)
Reason for trade
Reason for specialization
3

Production Possibilities Curve

Example
Entries are combinations of maximum total output of goods in
the
Adding
country
80 units Ag in the US requires giving up 200
units
of Mfg.
The
opportunity
cost of
CostAg =200/8
________ =2.5
______ Mfg/Ag
Ag (PAg)
0

U.S.
Ag Mfg
0 1000
80 800
160 600
240 400
320 200
400
0

Canada
Ag Mfg
0 400
60 320
120 240
180 160
240
80
300
0

Mex
Ag Mfg
0 100
40
80
80
60
120
40
160
20
200
0

4 (3 lines)
Plot each box of options on the Graph Below

Production Possibilities Curve

1400
US
1200
1000

(0,1000)

800

United States
PPC

(80,800)

Canada
Mexico

Manufacturing
600

Canada
PPC

400
200
0
0

Mexico
PPC
100

200

300

400

500

Agriculture

600

700
5

800

900

Opportunity Cost
Calculations
What is the opportunity cost of ag goods in each
country?

mfg goods given up per ag good produced

= 2.5 Mfg/Ag
Op cost of Ag in US (1000-800)/80-0)
____________
(80-60)/(80-40)=0.5 Mfg/Ag
Op cost of Ag in Mexico ____________
400/300
=1.3 Mfg/Ag
Op cost of Ag in Canada ___________

Mexico
Who has lowest op cost (P)of Ag ________
Who has comparative advantage (low cost) in
manufacturing?__________
US
Hence who should produce what if some of each is
desired?
Either
US________
Mexico _______
Canada ______
Mfg
Ag
6

Graphs Maximum Output

Options
GOAL: Graph total of the three countries
First, complete specialization in mfg goods
Second, let only low cost producer of ag gds
Mexico
specialize in ag gds (country_________)
Third let only low cost producer of mfg gds
produce mfg goods. (country _________)
U.S.
Other two produce ag gdsCanada
_______________
and Mexico
Last all three countries specialize in mfg gds.

Production Possibilities Curve

1. Have Mexico (low cost
producer) produce Ag
goods
2. Add Canada (medium cost
1400
producer) producing Ag
goods
1200

US
Can
ada

1000

800

Add US (high cost

producer) producing Ag
goods

Manufacturing
600

400

200

0
0

100

200

300

400

500

Agriculture

600

700

800

900

Conclusion: Comparative advantage causes the8 outward bow in

the World PPC

Book Example
Numbers changed to make Clearer
30

Shirley 24 C
Tom 24 N

25

Susan 24c/12n
Shirley
Tom 6c/24n
Specialized

20

No Specialization
Poorly specialized

15
10

Each produces
proportional
share

Shirley 12N
Tom 6 C

-4

11

16

21

26

31

36

Production Possibilities
Curve
Unattainable

Milk
X

Efficiency
Gets you to
The PPC.
Reallocation
Moves you along.

Efficient

X
X
X

Inefficient

X
Computers

Increasing Opportunity Cost

Last few units most expensive as you specialize.
10

PPC Shift Factors

Changes in Resources
Capital
Labor
Population
Skills (Human Capital)

Changes in Technology
Energy solutions will affect productivity
Productivity up

Natural occurrences
Disasters Colorado fires
Weather Hurricane Isaak
Discovery of oil
BP Oil Spill
11

Application of Comparative
Advantage
Sell/Export what you have a comparative advantage
in
Buy/Import goods you have a comparative
disadvantage in
Should you grow your own food?
Should you do your own ?
Answer: It depends on opportunity cost
Includes non-monetary elements

Trade affects different individuals/firms differently

Import competitor hurt
Consumer of imports benefits from lower cost
Consumer of exported good pays higher prices

Why/Why Not Specialize?

Pro

More output possible

Efficiently using resources
Lowest cost of goods produced
Economies of Scale
Size of Market

Con

National security (Ex.: US oil dependency)

Foreign Exchange issue
Control of Production and Distribution
Potential trading inequities
Can overspecialize
Size of Market