Absolute and Comparative Advantage AP Macroeconomics © Robin Foster.

Absolute and Comparative

AdvantageAP Macroeconomics

© Robin Foster

They want goods

Think of what we would do without if we didn’t trade.

To make money.

Nations trade for several reasons

Trade surplus-exports exceed imports.

Trade deficit-imports exceed exports.

The USA has a trade deficit.

A trade deficit=exports-imports

This does NOT mean the US government owes other countries money.

A trade is between companies within a country.

The national debt is different.

Trade-deficit or surplus

Ricardo argued that there is mutual benefit from trade even if one party (e.g. resource-rich country, highly-skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled laborer).

As long as each concentrates on the activities where it has relative productivity advantage.

David Ricardo

I have an absolute advantage, if I produce faster, more and more efficient

If I can produce a good or service at a lower opportunity cost than you then I have a comparative advantage.

Production based on comparative advantage is Specialization.

Absolute and Comparative Advantage

Let's use our tropical island example to identify who has absolute and comparative advantage in the production of fish and coconuts.


In one hour Tom can cut down 16 coconuts or catch 8 fish.

In one hour Wilson the volleyball can cut down 21 coconuts or catch 7 fish.


Make a chart like the one to the right

You can produce more that the other person/country.

Coconuts?

Fish?

Tom Wilson

Coconuts 16 21

fish 8 7

Absolute Advantage-output

So who has the absolute and comparative advantage in what product.


Tom Wilson

Coconuts/hour (A)

16 21

Fish/hour (B) 8 7

Coconuts: (other goes over)

Tom 8/16= .5

Wilson 7/21=.33

Fish: Other goes over)

Tom 16/8= 2

Wilson 21/7= 3

The person with the lowest number should produce that item.

Why? They are giving up the least of the other item to produce their item.

Tom Wilson

Coconuts (A)

16 21

Fish (B) 8 7

Comparative Advantage

The bottom line is that it is comparative advantage (opportunity cost) and not absolute advantage that yields an incentive for specialization and trade.

Now—Can Tom and Wilson trade with each other?

Example

David Ricardo

Ricky Ricardo

Bake Cakes

2 cakes/hr. 4 cakes/hr.

Make Pizza 6 pizzas/hr. 8 pizzas/hr.

http://www.youtube.com/watch?v=FpTBjRf8lGs

Example

David Ricardo

Ricky Ricardo

Bake Cakes



Who has the absolute advantage in baking cakes?Who has the absolute advantage in making pizza?

Example

David Ricardo

Ricky Ricardo

Bake Cakes



Why?Well, because 4 cakes>2 cakes & 8 pizzas>6 pizzas.

Example

David Ricardo

Ricky Ricardo

Bake Cakes



Who has the comparative advantage in baking cakes?Who has the comparative advantage in making pizza?

Example

Who has the comparative advantage in baking cakes?Who has the comparative advantage in making pizza?

Using a graph-another way to illustrate the problem. Convert to a chart.

Cakes

4

Ricky

2

David

6 8

Pizza

Output and input questions

Examples again

http://www.youtube.com/watch?v=z9SAzSm24qg

Absolute and Comparative Advantage AP Macroeconomics © Robin Foster.

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