Comparative Advantage
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights reserved.
Exchange and Opportunity Cost
Do It Yourself only when:
Opportunity cost < hired cost
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Exchange and Opportunity Cost
• A person has an absolute advantage at a
particular task if he or she can perform the task
in fewer hours than the other person
• A person has a comparative advantage at a
particular task if his or her opportunity cost of
performing the task is lower than the other
person’s opportunity cost
• Comparative advantage doesn’t just care about
your skill at a task, but about your skill at that
task compared to your skill at other tasks
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
The Principle of Comparative
Advantage
The Principle of Comparative Advantage
Everyone does best when each person (or each country)
concentrates on the activities for which his or her opportunity
cost is the lowest.
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Comparative Advantage
Example
Production
Times
Mary
Paula
Opportunity
Cost
Mary
Paula
Web Update
Bike Repair
20 minutes
30 minutes
10 minutes
30 minutes
Web Update
Bike Repair
2 repairs
1 repair
0.5 update
1 update
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Comparative Advantage
Example
Hourly Output
Mary
Paula
Web Update
3 updates
2 updates
Bike Repair
6 repairs
2 repairs
If both Mary and Paula spend half of their time producing both services:
If Paula specializes in producing “updates”:
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Sources of Comparative
Advantage
• Talent
• Natural resources
• Cultures or societal norms
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Production Possibilities Curve
24
Coffee (lb/day)
• A production
possibilities curve
illustrates the
combinations of
two goods that can
be produced with
given resources
• Scarcity Principle
16
8
– Give up one good to
get
another
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
A
Unattainable
Combination
B
Inefficient
Combination
C
D
4
8
12
Nuts (lb/day)
Opportunity Costs
A
12
Coffee (lb/day)
Coffee (lb/day)
24
B
16
C
8
A
B
8
C
4
D
4
8
D
12
Nuts (lb/day)
• Susan’s Opportunity cost of 1 nut
is 2 coffee
• Susan’s Opportunity cost of 1
coffee is ½ nut
8
16
24
Nuts (lb/day)
Tom's opportunity cost of 1 coffee is 2
nuts
Tom’s opportunity cost of 1 nut is ½
coffee
Gains from Specialization and
Trade
Coffee (lb/day)
24
Susan and Tom
exchange
12 nuts, 12 coffee
• Let’s assume that
preferred diet is half
nuts, half coffee
•
12
•
8
8 12
Nuts (lb/day)
24
No trade: 8 pounds of coffee
and 8 pounds of nuts
• Total output is 32 pounds
Specialization gives each
person 12 pounds of each
good
• Total output is 48 pounds
Coffee (1000s of lb/day)
Production Possibilities for an
Economy
100
95
90
A
B
• Some resources better at
coffee, some better at nuts
• The Principle of Increasing
Opportunity Cost
C
D
E
20
1
5
20
30
75
Nuts (1000s of lb/day)
80
77
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.
Shifts in PPC
Neutral Technical
Improvement
Coffee
Technical Improvement
in Coffee
Coffee
Nuts
Nuts
Coffee
Technical Improvement
in Nuts
Nuts
©McGraw-H © 2019 McGraw-Hill Education. ill Education. All rights
reserved.