Learn about the difference between absolute and comparative advantage and how these two key economic concepts help shape international. However, thinking about trade just in terms of geography and absolute advantage is incomplete. Trade really occurs because of comparative advantage. based on the idea of theory of absolute advantage extended it to incorporate theory of comparative ad- the technological relationship between inputs and.
So in that case, actually Patty would have an absolute advantage, but it just wouldn't be obvious from this right over here. But to make everything clear, I want to do a scenario where Charlie improved his productivity in some way and he actually has the absolute advantage in both products, and still show that as long as they have different comparative advantages, then it still makes sense for them to specialize. So let's do another scenario.
So Charlie has improved dramatically. So let's draw our little graph here. That's our cups axis, this is still our plates axis. But let's say that Charlie has improved dramatically. And so Charlie's PPF looks like this. So this is Charlie's PPF now looks like this. So in a given day he can produce - and let's just assume they're using the same number of inputs- so using the same number of inputs in a given day he can produce forty cups when Patty can only produce ten.
So he has the absolute advantage in cups. Or, in the same given day using the same inputs, he could produce forty plates while Patty can only produce thirty. So now Charlie, all of a sudden, has an absolute advantage in both products. But we'll see it still makes sense for them to specialize because they have different comparative advantages; they have different opportunity costs.
So let's figure this out. So we have all the same numbers for Patty - actually, let me copy and paste Patty's numbers right here. Actually we have access to her numbers right over here so I don't have to copy and paste it. But let's think of Charlie's new numbers now. So this is the PPF for Charlie. So this is our new PPF for Charlie. So he's expanded his PPF.
Comparative advantage and absolute advantage
So what is his opportunity costs? Say he's sitting here - so he's producing 40 cups - what would be his opportunity cost of producing 40 plates? Well to produce those forty plates, he would have to give up those forty cups. So his opportunity cost of forty plates is equal to forty cups. Or you divide both sides by forty: And this makes math very easy: Now given this new reality - so we've already established Charlie has an absolute advantage in both.
Using the same inputs he can do more of either of them.
Difference Between Absolute and Comparative Advantage
And remember, when you're talking about absolute advantage you have to think about the amount of inputs you use. Who's more productive in that way? But let's think about comparative advantage.
If we think about plates, who has a lower opportunity cost for producing a plate? Her opportunity cost for producing a plate is one-third of a cup.
Charlie's opportunity cost for producing a plate has improved, but it's still worse than Patty's. He has to spend one cup to make a plate, she only has to give up one-third of a cup to make a plate. So Patty still has a comparative advantage in plates. And if we look at the opportunity cost in cups, the opportunity cost for Charlie to make 1 cup is 1 plate.
So it's actually a little bit worse than it was before, but as we'll see it ends up being a good thing, he's just overall more productive. But his opportunity cost for one cup, he's giving up one plate now, when before he was producing one third of a plate. And that's because in the other scenario, he was more one-sided, I guess is one way to say it.
But his opportunity cost for producing a cup is still cheaper than Patty's. Her opportunity cost of producing a cup is three plates: While his is only one plate. So he still has the comparative advantage in cups. So Charlie should still specialize in cups. And to show that they can still get an outcome that is beyond even Charlie's Production Possibilities Frontier, let's think about how they could trade.
So Charlie's going to specialize in cups; he's going to sit right over there producing forty cups a day.
- Difference Between Absolute and Comparative Advantage
Let each of them have 5 employees, an equal amount of wood, tools, and other raw materials. Now, if A produces 10 candle stands and B produces 5 per hour, A is said to have an absolute advantage over B.
A country, firm, or an individual can have an absolute advantage in more than one product; however, experts advise against putting the same into practice.
For instance, if France can produce bottles of perfume and 80 gallons of wine in a month using workers. Italy produces 70 bottles of perfume and 80 gallons of wine in the same period, using the same number of workers. Now, even though France has an absolute advantage in both products, it would be more prudent to let Italy manufacture wine, since France is super-skilled and naturally blessed for the production of perfume.
Thus, if both nations would prefer manufacturing products they specialize in and import the ones for which the productivity is not as good as the other, they would both progress.
Comparative Advantage It is the ability to excel at producing goods at a lesser opportunity cost than the rest. Again, it can be applicable to people or companies or nations. For instance, if John is adept at making paper crafts by using just sufficient paper and thereby reduces the overall cost, he is said to have a comparative advantage over the others.
This theory is believed to have been developed by David Ricardo in It has been observed to obtain mutual gains in international trade. The most common example would be regarding two countries and two products. Let's say country X manufactures T-shirts and 50 skirts in an hour, while country Y manufactures 60 T-shirts and skirts in an hour.
If these two items are imported and exported between the two countries, the trade would be mutually beneficial. The factor here is not the item, but the opportunity cost it is getting produced at. Consider the second example of the previous post. In the same scenario, if B compromises on the available resources and still manages to produce an equal number of candle stands as A does, B is said to have a comparative advantage over A.
Consider a very random and uncomplicated instance. Say, a woman has opened a boutique. Initially, since she is starting out, she would have to do all the tasks herself, this includes writing accounts, making bills, folding clothes, etc. Very soon she would be efficient and skilled in these tasks too, along with being a good boutique owner and salesperson for her customers. As the business progresses, she will have established loyal clients, and consequently, she will hire a clerk to help her with her extra work.
Now, in this case, the clerk may or may not be as skilled as the owner in keeping accounts, yet, since the latter is concentrating on the task she specializes in, the clerk has a comparative advantage over her. This would be an economist's viewpoint. Factors of Differentiation Comparative Advantage Concept It occurs when a country produces better goods and services better than its competitors using the same amount of resources. It occurs when a country produces goods and services at a lower opportunity cost than its competitors.
Trade It represents a condition wherein the trade between 2 countries is not mutually beneficial.