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Comparative / Absolute Advantage and the gains from trade
Key terms comparative advantageTrade | 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 mindDon't confuse comparative and absolute advantage | Possible to have comparative advantage with no absolute advantage | Possible to have absolute advantage with no comparative advantage |
| | SpecialisationDo what you do best, trade for the rest Calculating comparative advantageWho 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 specialisationPossible 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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