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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 |
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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 |
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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).
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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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Created By
https://www.speedwell.com.au
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