The Principle of Comparative
Advantage
Comparative advantage is
the ability of a person (or
state, region, country) to
perform an activity or produce
a good or service at a lower
opportunity cost than
someone else (or some other
state, region, or country).
Liz’s Smoothie Bar
Lizzie can make smoothies or salads.
Her production possibilities are as
follows:
Measuring Liz’s Opportunity Cost
It takes me 90 seconds
to do one salad—90
seconds that could
have been used to
make one smoothie.
Thus:
1 smoothie = 1 salad
and
1 salad = 1 smoothie
Joe’s Smoothie Bar
Joe can make smoothies or salads. His
production possibilities are as follows:
Measuring Joe’s Opportunity Cost
It takes me 10 minutes
make one smoothie—I
could make 5 salads in
10 minutes.
Thus:
1 salad = 1/5 smoothie
and
1 smoothie = 5 salads
Absolute Advantage
Notice that Liz has an
absolute advantage over Joe—
that is, she can make more
salads and smoothies per hour.
Does it follow there would be
no advantages to specialization
and trade?
Liz has the comparative
advantage in smoothies, since
she can make them at lower
opportunity cost than Joe. Joe
has the comparative advantage
in salads—since he must
sacrifice 1/5 smoothie per salad;
whereas Liz must sacrifice 1
smoothie per salad.
Terms of Trade
I am willing to trade if I can get
more than one salad in
exchange for one smoothie.
I am willing to trade if I can get
more than one fifth of a
smoothie in exchange for one
salad (or pay less than 5 salads
1 smoothie)
1 smoothie buys 2 salads
Or:
2 salads buys one smoothie
These terms are
advantageous to
both Liz and Joe!!
Gains from Specialization
Complete Practice problem 3.5
on p. 84
Snowboards
25
20
Tony’s PPF
Patty’s PPF
0
10
50
Skis
a. Calculate Tony’s opportunity cost of a
snowboard.
b. Calculate patty’s opportunity cost of a
snowboard.
c. Who has the comparative advantage in
producing snowboards?
d. Who has the comparative advantage in
producing skis?
e. If the specialize and trade, how many
snowboards and skis will they produce?