Comparative / Absolute Advantage and the gains from trade
Key terms comparative advantage
Buying or selling
Everybody gains maximum benefit from doing what they do best and then trading
Ability to produce more than competitors using the same amount of resources
Ability to produce at a lower opportunity cost than competitors
The basis for trade is comparative advantage not absolute advantage
Keep in mind
Don't confuse comparative and absolute advantage
Possible to have comparative advantage with no absolute advantage
Possible to have absolute advantage with no comparative advantage
Do what you do best, trade for the rest
Calculating comparative advantage
Who has the lower opportunity cost?
Can be calculated as
# given up /
# produced of the alternate
We give up /
If we make
Lowest number = highest comparative advantage
E.g. Who has advantage out of 0.16 and .33
E.g. Who has advantage out of 6 and 3
If asked Who has the comparative advantage in picking strawberries then the # of strawberries is the numerator (top part of the fraction) and apples is the denominator (whole).
Gains from specialisation
Possible gains include:
Total production of goods and services is raised
Consumers have access to a greater variety of higher quality products. Eating apples and strawberries instead of just apples.
A bigger market
Specialisation and global trade increase the size of the market offering opportunities for economies of scale
Competition and lower prices:
Increased competition an incentive to minimise costs, keep prices down and therefore maintains low inflation. Also promotes R & D in new techs.