AP Economics
Mr. Bernstein
Module 4: Comparative Advantage
and Trade
September 22, 2014
AP Economics
Mr. Bernstein
Trade
• Trade improves standards of living for everyone
• Specialization - Adam Smith’s The Wealth of Nations
(1776)
• Markets are the mechanism that distributes goods
and services the meets wants and needs
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AP Economics
Mr. Bernstein
Comparative Advantage and Trade
• Comparative Advantage occurs when production by
one party has a lower opportunity cost than the
other
• Absolute Advantage occurs when one party has
lower production costs than another
• Trade can be beneficial when one party has an
absolute advantage in both products – comparative
advantage is all that is required, and everyone has a
comparative advantage at something!
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AP Economics
Mr. Bernstein
Production Possibilities Curves for two countries
4
AP Economics
Mr. Bernstein
Trading 100 Units of Malaria Medicine for 200 Cotton Shirts
1. Calculate the opportunity costs of production for each country
2. Determine the comparative advantage for each country
3. Determine if the terms of trade
are mutually beneficial
5
AP Economics
Mr. Bernstein
Trading 100 Units of Malaria Medicine for 200 Cotton Shirts
1. Calculate the opportunity costs of production for each country
2. Determine the comparative advantage for each country
3. Determine if the terms of trade are mutually beneficial
Bangladesh
United States
Cotton Shirts (C)
750C = 250M
1C = 1/3M
1000C =1000M
1C = 1M
Malaria Medicine
(M)
250M = 750C
1M = 3C
1000M =1000C
1M = 1C
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AP Economics
Mr. Bernstein
Trading 100 Units of Malaria Medicine for 200 Cotton Shirts
1. Calculate the opportunity costs of production for each country
2. Determine the comparative advantage for each country
3. Determine if the terms of trade are mutually beneficial
• Bangladesh has a comparative advantage in Cotton Shirts (C)
because they only give up 1/3 unit of medicine while The United
States must give up 1 unit of medicine to gain 1 cotton shirt.
• The United States has a comparative advantage in Malaria
Medicine (M) because they only give up 1 cotton shirt while
Bangladesh must give up 3 cotton shirts to gain 1 unit of medicine.
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AP Economics
Mr. Bernstein
Trading 100 Units of Malaria Medicine for 200 Cotton Shirts
1. Calculate the opportunity costs of production for each country
2. Determine the comparative advantage for each country
3. Determine if the terms of trade are mutually beneficial
• The terms of trade are mutually beneficial as long as they are
between the two countries’ opportunity costs.
• I.e.: 1/3 Unit of Medicine < 1 Cotton Shirt < 1 Unit of Medicine
• Bangladesh would not trade 4 shirts for 1 unit of medicine – they
would rather produce meds themselves, with opp. cost of 3 shirts
• US would not trade 2 units of medicine for 1 shirt – they would
rather produce the shirt themselves, with opp. cost of 1 unit of med.
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