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Comparative / Absolute Advantage Cheat Sheet by

Comparative / Absolute Advantage and the gains from trade

Key terms compar­ative advantage

Trade
Buying or selling
Specia­lis­ation
Everybody gains maximum benefit from doing what they do best and then trading
Absolute advantage
Ability to produce more than compet­itors using the same amount of resources
Compar­ative advantage
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
 

Specia­lis­ation

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
0.16
E.g. Who has advantage out of 6 and 3
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:
Higher output
Total production of goods and services is raised
Variety
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.
                               

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