Chapter 2: Comparative
Advantage
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1
Learning Objectives: Understand
1. The Principle of Comparative Advantage
2. The Principle of Increasing Opportunity Cost
(also called the Low-Hanging-Fruit Principle)
3. Factors that shift the menu of production
possibilities
4. The role of comparative advantage in
international trade
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Do It Yourself?
 Joe Jamail, a highly successful Lebanese-American
trial attorney, employs another attorney to write
his will
 Writing
your own will
 Opportunity cost of 2 hours
 Hiring someone to spend 4 hours
on your will
 Making the right economic choice
2 hours
$10,000+
$3,200
Priceless
 Do It Yourself only when
Opportunity cost < hired cost
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Production Advantages: Previous Example
From the previous example:
 Jamail
has an absolute advantage at preparing
his will

Because he can perform that task faster than another
lawyer
 Other
lawyer has a comparative advantage
at preparing the will

Because his opportunity cost of performing that task
is lower than Jamail’s
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Production Advantages
 Definitions
 Absolute


advantage
Lowest production cost
one person has an absolute advantage over another if he or
she takes fewer hours to perform a task than the other
person
 Comparative


advantage
Lower opportunity cost than someone else
one person has a comparative advantage over another if his
or her opportunity cost of performing a task is lower than
the other person’s opportunity cost
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Comparative Advantage Example
 Tiger Wood can mow his lawn in 2 hours. Or
film a television commercial of Nike and earn
$15000 in that 2 hours.
 Forest Gump can mow Wood’s lawn in 4 hours.
Or he could work at McDonald’s and earn $36.
 Absolute advantage?
 Comparative advantage?
 Gain from trade?
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The Principle of Comparative Advantage
The Principle of Comparative Advantage
Everyone does best when each concentrates
on the activity with the lowest opportunity cost
Opens doors for specialization  have you ever met
an engineer who is also a medical doctor? Or a
mechanic who is also a professor?  defines the basis
for trade among people and countries
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Comparative Advantage Example
Production Times
Web Update
Bike Repair
Ayden
20 minutes
10 minutes
Ghadah
30 minutes
30 minutes
 Ayden and Ghadah can each update web pages and
repair
 Who has absolute advantage in each task?
 Who has comparative advantage in each task?
 Lets assume there are 8 working hours in a day
Production Output
Web Update
Bike Repair
Ayden
24
48
Ghadah
16
16
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Comparative Advantage Example
Production Output
Web Update
Bike Repair
Ayden
24
48
Ghadah
16
16
Opportunity Cost
Ayden
Ghadah
Web Update
2 repairs
Bike Repair
0.5 update
1 repair
1 update
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Comparative Advantage Example
Production Times
Ayden
Ghadah
Web Update
20 minutes
30 minutes
Bike Repair
10 minutes
30 minutes
Hourly Output
Ayden
Web Update
3 updates
Bike Repair
6 repairs
2 updates
2 repairs
Ghadah
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Comparative Advantage Example
Hourly Output
Web Update
Bike Repair
Ayden
3 updates
6 repairs
Ghadah
2 updates
2 repairs
 Assume that 16 web updates are ordered
Ayden spends half his time at each activity: 12 updates and
24 repairs
 Ghadah produces the remaining 4 updates and spends the
last 6 hours of the day making 12 repairs
 Total output 16 updates and 36 repairs

 If specialization occurs then:16 updates and 48 repairs

12 more repairs for the same inputs!
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The Principle of Comparative Advantage
Two parties have different opportunity
costs for two activities
 Concentrate
on the activities in which you
have lower opportunity cost than other party
Identify the task with which the person or country
has a comparative advantage in
Total value of output increases with specialization


• By specializing on producing tasks with which a person or a
country has a comparative advantage, the opportunity for trade
exists
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Comparative Advantage:
Exercise
Ismail can wax a car in 20 minutes or
wash a car in 60 minutes. Kamal can
wax a car in 15 minutes or wash a car
in 30 minutes. What is each man's
opportunity cost of washing a car?
Who has a comparative advantage in
washing cars?
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Comparative Advantage:
Exercise
Who has absolute advantage in production
of pizza?
Who has absolute advantage in delivering
of pizza?
What about comparative advantage?
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Comparative Advantage:
Exercise
Hamid can produce 5 gallons of apple
cider or 2.5 ounces of feta cheese per
hour. Kariman produce 3 gallons of
apple cider or 1.5 ounces of feta
cheese per hour. Can Hamid and
Karim benefit from specialization and
trade? Explain.
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Comparative Advantage:
Exercise
 Pat and Kris are roommates. They make pizza and chicken
pie for their dinner. Pat takes 4 hours to make a chicken
pie and 2 hours to make a pizza. Kris takes 6 hours to
make a chicken pie and 4 hours to make a pizza.
a) What is each roommate’s opportunity cost of making a
pizza? Who has absolute advantage in making pizza?
Who has comparative advantage in making pizza?
b) If Pat and Kris trade foods with each other, who will
trade away pizza in exchange of chicken pie?
c) The price of pizza can be expressed in terms of chicken
pie. What is the highest price at which pizza can be
traded that would make both roommates better off?
What is the lowest price? Explain.
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Sources of Comparative Advantage
Where does comparative advantage come
from?
 At

the individual level
Talent
• Education, training and experience
 At


the national level
Natural resources
Cultures or societal norms
• Languages
• Institutions
- Value placed on craftsmanship
- Support for entrepreneurship
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Production Possibilities Curve (PPC)
 Unattainable
point
 Attainable point


Inefficient point
Efficient point
Coffee (kg/day)
 A graph of the combinations of two goods
that can be produced with given level of
resources
24 A
Unattainable
 Definitions
Combination
16
8
 Scarcity Principle
 Give
up one good to get
another
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B
Inefficient
Combination
C
D
4
8
12
Nuts (kg/day)
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Fatima’s Production Possibilities
Two goods: coffee and
nuts
6 hours per day
 Has nimble fingers 
better for picking coffee
1 hour of labor
Coffee (kg/day)
 Work
24
16
= 4 kg of coffee OR
= 2 kg of nuts
 Graph

shows options
8
A
B
C
D
4
8
12
Nuts (kg/day)
Negative slope
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Fatima’s Opportunity Cost
 Moving from C to A:
 Marginal cost: – 8 nut
 Marginal benefit: 16 coffee
Loss in nuts
Gain in coffee
• Opportunity cost of 1 coffee is
½ nut
24
Coffee (kg/day)
 Moving from A to B:
 Marginal cost : – 8 coffee
 Marginal benefit: 4 nuts
Loss in coffee
Gain in nuts
• Opportunity cost of 1 nut is
2 coffee
A
B
16
C
8
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8
D
12
Nuts (kg/day)
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PPC and Opportunity Cost
 Hints:
 Since
Fatima’s PPC is a straight line, its slope is constant
 The absolute value of the slope of Fatima’s PPC is the ratio
of its vertical intercept to its horizontal intercept:


(24 kg of coffee/day)/(12 kg of nuts/day) = (2 kg of coffee)/(1 kg
of nuts)  This ratio means that Fatima’s opportunity cost of an
additional kg of nuts is 2 kg of coffee
To say that Fatima’s opportunity cost of an additional kg of nuts is
2 kg of coffee is thus equivalent to saying that her opportunity
cost of a kg of coffee is ½ kg of nuts.
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Kamal 's Production Possibilities
Work 6 hours per day
 Productivity determines the slope of the PPC
 1 hour of labor
= 4 kg of nuts OR
A
12
= 2 kg of coffee
 Opportunity cost
8
 Marginal cost: – 4 coffee
 Marginal benefit: 8 nuts
4
 Kamal's opportunity cost of
1 coffee is 2 nuts
 His opportunity cost of
1 nut is ½ coffee
Coffee (kg/day)

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B
C
D
8
16
24
Nuts (kg/day)
22
Kamal meets Fatima
24
Coffee (kg/day)
 PPCs show comparative
advantage
 Fatima's curve is steeper,
better for coffee
 Kamal's curve is flatter,
better for nuts
 Comparative advantage is a
comparison
 To get 1 coffee
 Fatima gives up ½ nuts
 Kamal gives up 2 nuts
Fatima’s PPC
12
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Kamal’s PPC
12
Nuts (kg/day)
24
23
Gains from Specialization and Trade
Without trade, each person can consume
along his production possibilities curve
 What
you produce determines what you
consume
With trade, each person's consumption can
be greater than production
 Produce
according to comparative advantage
 Trade to get what you want
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Gains from Specialization and Trade
Coffee (kg/day)
24
Fatima and Kamal
exchange
12 nuts, 12 coffee
12
8
8 12
Nuts (kg/day)
24
 Preferred diet is half nuts,
half coffee
 No trade: 8 kg of coffee
and 8 kg of nuts
 Total output is 32 kgs
 Specialization gives each
person 12 kg of each
good
 48 total kg
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Gains from Specialization and Trade
Fatima's PPC
Coffee (kg/day)
24
Trade
benefits
With trade
12
Kamal's PPC
4
No trade
4
12
Nuts (kg/day)
24
 Benefits increase when
differences in opportunity
cost increase
 Fatima's opportunity cost of
nuts increase to 6 coffee
 Kamal's opportunity cost of
coffee increases to 6 nuts
 No trade: 3.4 nuts and
3.4 coffee each
 With trade: 12 nuts and
12 coffee each
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PPF: Exercise
Consider a society consisting only of
Amina, who allocates her time between
sewing dresses and baking bread. Each hour
she devotes to sewing dresses yields 4
dresses and each hour she devotes to
baking bread yields 8 loaves of bread. If
Amina works a total of 8 hours per day,
graph her production possibilities curve.
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PPF: Exercise
Which of the points listed below is efficient? Which
is attainable?
a) 28 dresses per day, 16 loaves per day.
b) 16 dresses per day, 32 loaves per day.
c) 18 dresses per day, 24 loaves per day.
Suppose that a sewing machine is introduced that
enables Amina to sew 8 dresses per hour rather
than only 4. Show how this development shifts her
production possibilities curve.
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Gain from Specialization:
Exercise
 Fatima can pick 4 kg of coffee in an hour or gather 2 kg of
nuts. Kamal can pick 2 kg of coffee in an hour or gather 4
kg of nuts. Each works 6 hours per day.
a) What is the maximum number of kg of coffee the two
can pick in a day?
b) What is the maximum number of kg of nuts the two can
gather in a day?
c) If Fatima and Kamal were picking the maximum number
of kg of coffee when they decided that they would like
to begin gathering 4 kg of nuts per day, who would
gather the nuts, and how many kg of coffee would they
still be able to pick?
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Gain from Specialization:
Exercise
d) Now suppose Fatima and Kamal were gathering the
maximum number of kg of nuts when they decided that they
would like to begin picking 8 kg of coffee per day. Who
would pick the coffee, and how many kg of nuts would they
still be able to gather?
e) Would it be possible for Fatima and Kamal in total to
gather 26 kg of nuts and pick 20 kg of coffee each day? If so,
how much of each good should each person pick?
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Gain from Specialization:
Exercise
f) Is the point (30 kg of coffee per day, 12 kg of nuts per day)
an attainable point? Is it an efficient point? What about the
point (24 kg of coffee per day, 24 kg of nuts per day)?
g) On a graph with kg of coffee per day on the vertical axis
and kg of nuts per day on the horizontal axis, show all the
points you identified parts a–f. Connect these points with
straight lines. Is the result the PPC for the economy
consisting of Fatima and Kamal?
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Gain from Specialization:
Exercise
h) Suppose that Fatima and Kamal could buy or sell coffee
and nuts in the world market at a price of $2 per kg for
coffee and $2 per kg for nuts. If each person specialized
completely in the good for which he or she had a
comparative advantage, how much could they earn by selling
all their produce?
i)At the prices just described, what is the maximum amount
of coffee Fatima and Kamal could buy in the world market?
The maximum amount of nuts? Would it be possible for
them to consume 40kg of nuts and 8kg of coffee each day?
j) In light of their ability to buy and sell in world markets at
the stated prices, show on the same graph all combinations
of the two goods it would be possible for them to consume.
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Production Possibilities for an Economy
Coffee (1000s of kg/day)
 Two goods: coffee and nuts
 Multiple people
 Different opportunity costs
100
95
90
A
B
 Intercepts show maximum
production of one good
 Some resources better at
coffee, some better at nuts
C
D
E
20
15
20
30
Nuts (1000s of kg/day)
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75
80
77
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The Principle of Increasing Opportunity Cost
Coffee (1000s of kg/day)
 Maximum coffee: 100,000 kg / day
 Give up 5,000 kg coffee, get 20,000 kg of nuts (A  B)
 Give up another 5,000 kg of coffee, get an 10,000 additional kg of
nuts (B C)
100
95
90
A
B
C
D
E
20
15
20
30
Nuts (1000s of kg/day)
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75
80
77
34
Start with resources
with lowest
opportunity cost
Then move to next
highest opportunity
cost
And still higher
opportunity cost
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Decreasing productivity
The Principle of Increasing Opportunity Cost
35
The Principle of Increasing Opportunity Cost
 PPC is bow-shaped because of increasing opportunity cost
 Also known as the “low-hanging-fruit principle”
 1st: It is easier to pick the low-hanging-fruit

2nd: if the fruit picker does not want to pick the
whole tree then it is still a better choice since the
high-hanging-fruit are more difficult to get to

3rd: if the fruit picker wants to pick the whole tree
then it is still a better choice since he can enjoy some
fast revenue from the sales of the easy to pick
sooner
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The Dynamic Economy
What shifts the PPC?
A

PPC represents current choices
Changes in choices occur over time due to
• More resources
- Investment in capital
- Population growth
• Improvements in technology
- More specialization: start-up and switching costs
• Increases in knowledge
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Shifts in PPC
Neutral Technical
Change
Coffee
Technical Change
in Coffee
Coffee
Nuts
Nuts
Coffee
Technical Change
in Nuts
Nuts
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Some Countries Resist Specialization
Specialization is easier when
 Population
density passes a threshold
 Markets are connected


Transportation for goods
Communications for services
 Legal
framework supports business
 Financial markets enable start-ups
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PPF: Exercise
a)
If this restaurant makes 75 salads in
one hour, approximately how many
pizzas can it also make in that same
hour, assuming efficient production?
b) Moving from Point C to Point B,
the opportunity cost of 25 more
salads is ____.
c) Moving from Point B to Point A,
the opportunity cost of 25 more
salads is _____ .
d) As salad production increases, the
opportunity cost of making an
additional salad ________ .
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Too Much Specialization?
Imagine this:
 Your
hair stylist only cuts blonde hair
 A professor for each chapter!
 Seven bookstores, each open a different day of
the week
 A grocery store for every type of food
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Comparative Advantage and International
Trade
Principle of Comparative Advantage and
gains from trade apply worldwide
 Potentially
large gains from trading with
different and distant countries
Controversial trade
 Benefits
the society broadly
 Costs are concentrated


Some industries
People who lose their jobs
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