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Chapter 2 - Comparative Advantage

The document discusses the principle of comparative advantage and how it allows for gains from trade. It explains how even if one country has an absolute advantage in all goods, comparative advantage allows for specialization and mutually beneficial trade based on opportunity costs. Countries can benefit from trading with others based on their different costs of production from factors like resources and skills.

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Noura Ahmed
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29 views16 pages

Chapter 2 - Comparative Advantage

The document discusses the principle of comparative advantage and how it allows for gains from trade. It explains how even if one country has an absolute advantage in all goods, comparative advantage allows for specialization and mutually beneficial trade based on opportunity costs. Countries can benefit from trading with others based on their different costs of production from factors like resources and skills.

Uploaded by

Noura Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Chapter 2

Comparative Advantage
“If we ourselves produce all we need to have in order to survive,
we will be very poor..”

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©2012 The McGraw-Hill Companies, All Rights Reserved
Learning Objectives: Understand

1.- The Principle of Comparative Advantage


2.- The Benefits of Trade in the PPF
3.- Absolute Advantage vs Comparative
Advantage
4.- The Link between Opportunity Cost and
Comparative Advantage
5.- The Role of Comparative Advantage in
International Trade.

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©2012 The McGraw-Hill Companies, All Rights Reserved
 Trade can make everyone better off. Short vs long run.

 Everyday we rely on people from around the world, people


we don’t know, to provide us with goods and services we
enjoy.

 Those people who provide us with goods and services are


not acting out of generosity or concern for our welfare,
they are getting something in return.

 Autarky is a situation where no trade exist.


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©2012 The McGraw-Hill Companies, All Rights Reserved
Production Possibilities

The importance of trade can be observed in the


production possibilities frontier. For example:

Suppose we have a rancher and a farmer working


8 hours/day and can devote this time to growing
potatoes, rising cattle, or a combination of the two.

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©2012 The McGraw-Hill Companies, All Rights Reserved
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©2012 The McGraw-Hill Companies, All Rights Reserved
 In this graph we can see the amounts of meat and potatoes that the farmer can produce.

 If the farmer devotes all 8 hours of his time to potatoes, he produces 32 ounces of
potatoes and no meat.
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©2012 The McGraw-Hill Companies, All Rights Reserved
 In this graph we can see the amounts of meat and potatoes that the rancher can produce.

 If the rancher devotes all 8 hours of his time to potatoes, she produces 48 ounces of potatoes
and no meat.
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©2012 The McGraw-Hill Companies, All Rights Reserved
Specialization and Trade

The rancher proposes the farmer the following:

Use all your time (8 hours/day) to produce 32 ounces of


potatoes.

Give me 15 ounces of potatoes and in exchange I’ll give you 5


ounces of meat.

So, in the end, you will eat 17 ounces of potatoes and 5 ounces
of meat every day, instead of 16 ounces of potatoes and 4
ounces of meat you now get.

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©2012 The McGraw-Hill Companies, All Rights Reserved
How Trade Increases the
Farmer’s Consumption

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©2012 The McGraw-Hill Companies, All Rights Reserved
What’s good for the rancher?

If the rancher spends 6 hours/day rising cattle and


2 hours/day (total 8 hours/day) growing potatoes,
he’ll produce 18 ounces of meat and 12 ounces of
potatoes.
After giving the farmer 5 ounces of meat in
exchange for 15 ounces of potatoes, he’ll have 13
ounces of meat and 27 ounces of potatoes to eat in
one day.
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©2012 The McGraw-Hill Companies, All Rights Reserved
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©2012 The McGraw-Hill Companies, All Rights Reserved
If the rancher is better at both rising cattle
and growing potatoes, how can the farmer
ever specializes in doing what he does best?

To answer this question we need to


understand the difference between absolute
advantage and comparative advantage.

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©2012 The McGraw-Hill Companies, All Rights Reserved
Production Advantages

 Definitions
 Absolute advantage
 Lowest production cost
 one person has an absolute advantage over another if he or she
takes fewer hours to perform a task than the other person

 Comparative advantage
 Lower opportunity cost than someone else
 one person has a comparative advantage over another if his or
her opportunity cost of performing a task is lower than the other
person’s opportunity cost

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©2012 The McGraw-Hill Companies, All Rights Reserved
The Principle of Comparative Advantage

The Principle of Comparative Advantage


Everyone does best when each concentrates
on the activity with the lowest opportunity cost

Opens doors for specialization  defines the basis for trade


among people and countries

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©2012 The McGraw-Hill Companies, All Rights Reserved
Sources of Comparative Advantage

 Where does comparative advantage come from?


 At the individual level
 Talent
• Education, training and experience
 At the national level
 Natural resources
 Cultures or societal norms
• Languages
• Institutions
- Value placed on craftsmanship
- Support for entrepreneurship

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©2012 The McGraw-Hill Companies, All Rights Reserved
Comparative Advantage and International
Trade

 Principle of Comparative Advantage and


gains from trade apply worldwide.
 Potentially large gains from trading with
different and distant countries
 Controversial trade
 Benefits the society broadly
 Costs are concentrated
 The decision to trade is based on marginal
benefits vs marginal costs
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©2012 The McGraw-Hill Companies, All Rights Reserved

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