3.5.1
Absolute & Comparative Advantage
Comparative Advantage
Comparative Advantage
Free trade can allow countries to specialize in the goods they are most efficient at producing. Trade means that they can buy some goods from other countries, rather than producing them themselves.
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Opportunity cost of production
Opportunity cost of production
- If a country produces sugar, it has an opportunity cost of production.
- The labor and capital used to make sugar cannot be used to make wheat at the same time.
- E.g. if Brazil can produce a lot of sugar cane per acre but not much wheat, and the US can produce a lot of wheat but not sugar cane, then the US has a lower opportunity cost of producing wheat than Brazil.
- This can be shown using production possibility frontiers (PPFs), which are also known as production possibility curves (PPCs).
Absolute advantage
Absolute advantage
- A country has an absolute advantage in producing a good over another country if it uses fewer resources to produce that good (i.e. It can produce a good more efficiently than other countries).
- Absolute advantage can be the result of a country’s natural endowment. For example, extracting oil in Saudi Arabia is pretty much just a matter of “drilling a hole.” Producing oil in other countries can require considerable exploration and costly technologies for drilling and extraction—if they have any oil at all.
Comparative advantage
Comparative advantage
- A country has a comparative advantage in producing a good over another country if it has a lower opportunity cost of producing that good than other countries.
- Countries tend to have different opportunity costs of producing a specific good, either because of different climates, geography, technology, or skills.
- The disparity in comparative advantages between economies provides the basis for international trade.
- Think of comparative advantage as what a country is least bad at - they all have to produce something!
Example of a Comparative Advantage
Example of a Comparative Advantage
Comparative advantages between economies tend to be the result of different climates, geography, technology, or skills.
Comparative advantage in practice
Comparative advantage in practice
- Suppose the US and Brazil need to decide how much they will produce of two crops: sugar cane and wheat.
- Due to its climatic conditions, Brazil can produce quite a bit of sugar cane per acre but not much wheat. Conversely, the U.S. can produce large amounts of wheat per acre, but not much sugar cane.
- Clearly, Brazil has a lower opportunity cost of producing sugar cane (in terms of wheat) than the U.S. The reverse is also true: the U.S. has a lower opportunity cost of producing wheat than Brazil.
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Comparative advantage in practice
Comparative advantage in practice
- This situation can be illustrated using two PPCs, as shown above.
Comparative advantage in practice
Comparative advantage in practice
- The U.S. PPC is flatter than the Brazil PPC implying that the opportunity cost of wheat in terms of sugar cane is lower in the U.S. than in Brazil.
- Conversely, the opportunity cost of sugar cane is lower in Brazil. The U.S. has comparative advantage in wheat, and Brazil has comparative advantage in sugar cane.
1Microeconomics
1.1Competitive Markets: Demand & Suply
1.2Elasticity
1.3Government Intervention
1.4Market Failure
1.4.1Types of Market Failure
1.4.2Introduction to Externalities
1.4.3Negative Externalities
1.4.4Policy for Negative Externalities
1.4.5Positive Externalities
1.4.6The Deadweight Welfare Loss of Externalities
1.4.7Case Study - The Externalities of Education
1.4.8Public Goods & the Free-Rider Problem
1.4.9Asymmetric Information
1.4.10End of Topic Test - Market Failure
1.4.11Application Questions - Market Failure
1.5HL: Theory of the Firm & Market Structures
2Macroeconomics
2.1The Level of Overall Economic Activity
2.2Aggregate Demand & Aggregate Supply
2.2.1The Aggregate Demand Curve
2.2.2Components of Aggregate Demand
2.2.3Shape of the Aggregate Demand Curve
2.2.4Shifts in Aggregate Demand
2.2.5IB Multiple Choice - Aggregate Demand
2.2.6Short & Long-Run Aggregate Supply
2.2.7Alternative Models of LRAS
2.2.8Equilibrium in the AD-AS Model
2.2.9Output Gaps & the AD-AS Model
2.3Macroeconomic Objectives
2.3.1Introduction to Unemployment
2.3.2Limitations of Unemployment
2.3.3Types of Unemployment
2.3.4Causes & Impact of Unemployment
2.3.5Defining Inflation
2.3.6Measuring Inflation
2.3.7Use of Index Numbers
2.3.8The Consumer Price Index
2.3.9Consequences of Inflation
2.3.10Causes of Inflation
2.3.11Inflation & Unemployment Tradeoff
2.3.12The Short-Run Phillips Curve
2.3.13The Long-Run Phillips Curve
2.4Economic Growth, Poverty & Inequality
2.5Fiscal Policy
2.6Monetary Policy
2.7Supply-Side Policies
3The Global Economy
3.1International Trade
3.2Exchange Rates
3.3The Balance of Payments
3.4Economic Integration
3.5Terms of Trade
3.6Economic Development
3.7The Role of Domestic & International Factors
3.8The Role of International Trade
3.9The Role of Foreign Aid
Jump to other topics
1Microeconomics
1.1Competitive Markets: Demand & Suply
1.2Elasticity
1.3Government Intervention
1.4Market Failure
1.4.1Types of Market Failure
1.4.2Introduction to Externalities
1.4.3Negative Externalities
1.4.4Policy for Negative Externalities
1.4.5Positive Externalities
1.4.6The Deadweight Welfare Loss of Externalities
1.4.7Case Study - The Externalities of Education
1.4.8Public Goods & the Free-Rider Problem
1.4.9Asymmetric Information
1.4.10End of Topic Test - Market Failure
1.4.11Application Questions - Market Failure
1.5HL: Theory of the Firm & Market Structures
2Macroeconomics
2.1The Level of Overall Economic Activity
2.2Aggregate Demand & Aggregate Supply
2.2.1The Aggregate Demand Curve
2.2.2Components of Aggregate Demand
2.2.3Shape of the Aggregate Demand Curve
2.2.4Shifts in Aggregate Demand
2.2.5IB Multiple Choice - Aggregate Demand
2.2.6Short & Long-Run Aggregate Supply
2.2.7Alternative Models of LRAS
2.2.8Equilibrium in the AD-AS Model
2.2.9Output Gaps & the AD-AS Model
2.3Macroeconomic Objectives
2.3.1Introduction to Unemployment
2.3.2Limitations of Unemployment
2.3.3Types of Unemployment
2.3.4Causes & Impact of Unemployment
2.3.5Defining Inflation
2.3.6Measuring Inflation
2.3.7Use of Index Numbers
2.3.8The Consumer Price Index
2.3.9Consequences of Inflation
2.3.10Causes of Inflation
2.3.11Inflation & Unemployment Tradeoff
2.3.12The Short-Run Phillips Curve
2.3.13The Long-Run Phillips Curve
2.4Economic Growth, Poverty & Inequality
2.5Fiscal Policy
2.6Monetary Policy
2.7Supply-Side Policies
3The Global Economy
3.1International Trade
3.2Exchange Rates
3.3The Balance of Payments
3.4Economic Integration
3.5Terms of Trade
3.6Economic Development
3.7The Role of Domestic & International Factors
3.8The Role of International Trade
3.9The Role of Foreign Aid
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