Comparative Advantage and Trade · AP® Microeconomics AP Microeconomics

Absolute vs. comparative advantage

Two different questions can be asked about who is "better" at a job.

Absolute advantage is just a comparison of productivity: who is faster, who makes more per hour.

Opportunity cost is what you give up to get something. If an hour of mowing means one hour of not washing cars, the cars you could have washed are the cost of the lawns. Comparative advantage is about what you give up, not about how fast you are.

The two ideas can point in different directions. A producer can be better at everything (absolute advantage in every good) and still have a comparative advantage in only one of them. Because every hour spent on one good is an hour taken away from the other, with two producers and two goods, nobody can have the lowest opportunity cost in both goods (unless their opportunity costs are exactly equal, in which case neither has a comparative advantage).

Practice★☆☆

Define absolute advantage and comparative advantage. Then explain which of the two is based on opportunity cost.

Solve

Practice★☆☆

Liam can make 10 sandwiches or 5 salads in an hour. Sofia can make 6 sandwiches or 4 salads in an hour. Who has the absolute advantage in making sandwiches? Who has the…

Liam can make 10 sandwiches or 5 salads in an hour. Sofia can make 6 sandwiches or 4 salads in an hour. Who has the absolute advantage in making sandwiches? Who has the absolute advantage in making salads? Explain.

Solve

Finding opportunity cost

To find a comparative advantage, first compute each producer's opportunity cost. There are two common ways, depending on how the data are given.

Output method (units per hour)

If the data say "in one hour, this person can make X of good A or Y of good B," then:

$$\text{opp. cost of 1 unit of A} = \frac{\text{units of B given up}}{\text{units of A gained}} = \frac{Y}{X}$$

The opportunity cost of one unit of B is the reciprocal, $\dfrac{X}{Y}$.

Input method (hours per unit)

If the data say "it takes this many hours to make one unit," then divide the hours:

$$\text{opp. cost of 1 unit of A} = \frac{\text{hours per unit of A}}{\text{hours per unit of B}}$$

This works because the hours spent on A could have made that many units of B instead.

Output method: the food truck

Ethan and Olivia work a taco truck. In one hour, Ethan can make 12 tacos or 6 burritos. Olivia can make 6 tacos or 2 burritos. Who has the comparative advantage in each food?

Step 1: Opportunity cost of one taco.

Ethan gives up 6 burritos to make 12 tacos, so one taco costs him $\frac{6}{12} = 0.5$ burrito.

Olivia gives up 2 burritos to make 6 tacos, so one taco costs her $\frac{2}{6} \approx 0.33$ burrito.

Step 2: Opportunity cost of one burrito (the reciprocals).

Ethan: $\frac{12}{6} = 2$ tacos. Olivia: $\frac{6}{2} = 3$ tacos.

Step 3: Compare.

Olivia's cost of a taco (0.33 burrito) is lower than Ethan's (0.5 burrito), so Olivia has the comparative advantage in tacos.

Ethan's cost of a burrito (2 tacos) is lower than Olivia's (3 tacos), so Ethan has the comparative advantage in burritos.

Step 4: Absolute advantage.

Ethan makes more of both goods per hour, so he has an absolute advantage in both. Olivia still has a comparative advantage in tacos.

Input method: the school project

Camila takes 1 hour to make a poster and 3 hours to make a video. Noah takes 2 hours to make a poster and 4 hours to make a video. Who has the comparative advantage in posters?

Step 1: Camila's opportunity cost of one poster.

One hour of poster work replaces $\frac{1}{3}$ of a video, so the cost is $\frac{1}{3}$ video.

Step 2: Noah's opportunity cost of one poster.

$\frac{2}{4} = \frac{1}{2}$ video.

Your turn. Who has the comparative advantage in posters? In videos? Does anyone have an absolute advantage in both? Try it in your notebook before you continue.

Camila has the comparative advantage in posters ($\frac{1}{3} < \frac{1}{2}$). Noah has it in videos: his cost of a video is 2 posters, while Camila's is 3. Camila needs fewer hours for both goods, so she has the absolute advantage in both.

Here is the comparison as a picture. Each line shows everything one producer can make in one hour (a production possibilities line with constant opportunity cost). A flatter line means a lower opportunity cost of the good on the horizontal axis.

Olivia's line is flatter. It falls $\frac{2}{6}$ burrito per taco, while Ethan's falls $\frac{6}{12}$ burrito per taco. The flatter line belongs to the producer who gives up fewer burritos for each taco, and that is Olivia.

Practice★☆☆

In one hour, Emma can mow 2 lawns or trim 4 hedges. Calculate Emma's opportunity cost of mowing one lawn, in hedges, and her opportunity cost of trimming one hedge, in…

In one hour, Emma can mow 2 lawns or trim 4 hedges. Calculate Emma's opportunity cost of mowing one lawn, in hedges, and her opportunity cost of trimming one hedge, in lawns.

Solve

Practice★★☆

In one day, Texas can produce 120 tons of beef or 60 tons of cotton. Oklahoma can produce 80 tons of beef or 80 tons of cotton. Assume both have constant opportunity…

In one day, Texas can produce 120 tons of beef or 60 tons of cotton. Oklahoma can produce 80 tons of beef or 80 tons of cotton. Assume both have constant opportunity costs.

(a) Calculate each state's opportunity cost of 1 ton of beef, in tons of cotton.

(b) Which state has the comparative advantage in beef? In cotton?

(c) Does either state have an absolute advantage in both goods? Explain.

Solve

Who should specialize in what?

The rule is simple:

The reason is that, in total, the world gives up less. If Olivia makes tacos (cost 0.33 burrito each) instead of Ethan (cost 0.5 burrito each), fewer burritos are sacrificed for the same tacos. Every shift of production toward the lower-cost producer increases total output.

When the data come as a table of hours or units, you can also find the maximum output of each good: divide the hours available by the hours per unit.

A weekly production table

Alpha and Beta each have 100 labor hours per week. Alpha needs 2 hours per ton of wheat and 4 hours per ton of rice. Beta needs 5 hours per ton of wheat and 5 hours per ton of rice. Find the opportunity costs and show the gain from specializing.

Step 1: Maximum output.

Alpha: $\frac{100}{2} = 50$ tons of wheat or $\frac{100}{4} = 25$ tons of rice.

Beta: $\frac{100}{5} = 20$ tons of wheat or 20 tons of rice.

Step 2: Opportunity cost of one ton of wheat.

Alpha: $\frac{2}{4} = 0.5$ ton of rice. Beta: $\frac{5}{5} = 1$ ton of rice.

Alpha has the comparative advantage in wheat. Beta's cost of rice is 1 ton of wheat, while Alpha's is 2, so Beta has the comparative advantage in rice.

Step 3: No trade, hours split equally.

Alpha: 50 hours on wheat gives 25 tons, and 50 hours on rice gives 12.5 tons.

Beta: 50 hours on wheat gives 10 tons, and 50 hours on rice gives 10 tons.

Total: 35 tons of wheat and 22.5 tons of rice.

Step 4: Specialize.

Alpha puts its hours into wheat: 50 tons. Beta puts its hours into rice: 20 tons.

That is 15 more tons of wheat but 2.5 fewer tons of rice. Compare the two changes: the world gives up 2.5 tons of rice but gains 15 tons of wheat. Since Alpha can swap 1 ton of rice for 2 tons of wheat ($2.5 \times 2 = 5$), the 15 tons of wheat is far more than enough to make up for the 2.5 tons of rice lost. If they trade at a fair price, both can end up with more.

Practice★★☆

The table shows how many units each country produces in one hour of labor. | | Cars | Bicycles | |---|---|---| | Country X | 4 | 20 | | Country Y | 2 | 4 | (a) Which…

The table shows how many units each country produces in one hour of labor.

	Cars	Bicycles
Country X	4	20
Country Y	2	4

(a) Which country has the absolute advantage in each good?

(b) Calculate each country's opportunity cost of one car, in bicycles.

(c) Which country has the comparative advantage in cars? Explain why Country Y can still gain from trade even though it has no absolute advantage.

Solve

Practice★★★

Two neighboring countries, Alpha and Beta, each have 100 hours of labor available per week and constant opportunity costs. Hours needed to produce one unit: | | Hours…

Two neighboring countries, Alpha and Beta, each have 100 hours of labor available per week and constant opportunity costs. Hours needed to produce one unit:

	Hours per ton of wheat	Hours per ton of rice
Alpha	2	4
Beta	5	5

(a) Calculate the maximum output of each good for each country if it devotes all hours to that good.

(b) Calculate each country's opportunity cost of one ton of wheat in tons of rice, and determine who has the comparative advantage in each good.

(c) Without trade, each country splits its hours equally between wheat and rice. Calculate the total output of each good for each country, and the world totals.

(d) Now each country specializes completely in the good in which it has a comparative advantage. Calculate world production of each good.

(e) Alpha trades 10 tons of wheat to Beta in exchange for 8 tons of rice. Decide whether each country is better off compared with part (c), using Alpha's and Beta's consumption of each good, assuming Alpha has all of its wheat to trade and Beta has all of its rice to trade after the specialization in part (d).

Solve

Terms of trade and gains from trade

Once Ethan and Olivia specialize, they need to trade. The terms of trade are the price at which one good is exchanged for the other (here, tacos per burrito).

Ethan's opportunity cost of a burrito is 2 tacos, and Olivia's is 3 tacos. Think about each one's point of view:

Ethan will sell a burrito only if he gets more than 2 tacos for it. Otherwise, he could just make the tacos himself.
Olivia will buy a burrito only if she pays less than 3 tacos. Otherwise, she could make it herself at that cost.

For the burrito, the range is 2 to 3 tacos.

Gains from trade with one hour each

Each person has one hour. Before trade, each splits the hour evenly: Ethan makes 6 tacos and 3 burritos, and Olivia makes 3 tacos and 1 burrito. Show that they can both gain from trade.

Step 1: Total before trade.

Tacos: $6 + 3 = 9$. Burritos: $3 + 1 = 4$.

Step 2: Specialize.

Olivia spends the whole hour on tacos: 6 tacos. Ethan spends $\frac{1}{4}$ hour on tacos (3 tacos) and $\frac{3}{4}$ hour on burritos (4.5 burritos).

Total: 9 tacos and 4.5 burritos, which is 0.5 burrito more than before.

Step 3: Trade at 2.4 tacos per burrito (inside the 2 to 3 range).

Olivia sends Ethan 3 tacos, and Ethan sends her $\frac{3}{2.4} = 1.25$ burritos in return.

Step 4: Compare.

Olivia: 3 tacos and 1.25 burritos, versus 3 tacos and 1 burrito before. She is better off.

Ethan: $3 + 3 = 6$ tacos and $4.5 - 1.25 = 3.25$ burritos, versus 6 tacos and 3 burritos before. He is better off too.

Now back to the start. Mateo is better at both jobs, but his advantage is bigger in one of them, which means his opportunity cost is lower there. If he works on the job where his cost is lower and Chloe takes the other, they get more done in total and can share the gain. Being the best at everything is not a reason to do everything.

Practice★★☆

Marcus and Priya work for a day on a school project. In one hour, Marcus can write 3 pages or make 6 slides. Priya can write 2 pages or make 8 slides. (a) Find each…

Marcus and Priya work for a day on a school project. In one hour, Marcus can write 3 pages or make 6 slides. Priya can write 2 pages or make 8 slides.

(a) Find each student's opportunity cost of one page, in slides.

(b) Who should specialize in writing pages and who in making slides? Explain.

(c) Give a trade, as a price of one page in slides, that would make both students better off, and justify it.

Solve

Practice★★★

Jayden and Camila run a lemonade stand and a cookie stand, working 8 hours a day. In one hour, Jayden can make 20 cups of lemonade or 10 cookies. Camila can make 12 cups…

Jayden and Camila run a lemonade stand and a cookie stand, working 8 hours a day. In one hour, Jayden can make 20 cups of lemonade or 10 cookies. Camila can make 12 cups of lemonade or 8 cookies.

(a) Calculate each person's opportunity cost of one cookie, in cups of lemonade.

(b) Determine who has the comparative advantage in each good, and whether either has an absolute advantage in both.

(c) Find the range of prices, in cups of lemonade per cookie, at which trade would benefit both. Explain why prices outside the range would not.

(d) Suppose they specialize according to comparative advantage and work all 8 hours each. Calculate total production of each good. Compare it with the total if each splits time equally between the two goods.

(e) Explain whether a price of 1.9 cups of lemonade per cookie is mutually beneficial, and who gains more at that price.

Solve

Summary

Let's practice! 8 exercises in this section

★☆☆ Define absolute advantage and comparative advantage. Then explain which of the two is…★☆☆ In one hour, Emma can mow 2 lawns or trim 4 hedges. Calculate Emma's opportunity cost of…★☆☆ Liam can make 10 sandwiches or 5 salads in an hour. Sofia can make 6 sandwiches or 4…