3.2 HL
Comparative Advantage
B & D, pages 261-265
3.2 Learning Objectives
1.
2.
3.
4.
Describe the differences between countries in in terms of factor
endowments and the levels of technology.
Explain the theories of absolute and comparative advantage
and illustrate each by a sketch diagram.
Calculate opportunity costs from a set of data in order to
identify comparative advantage and illustrate on a diagram.
Discuss the real-world relevance and limitations of the theory
of comparative advantage, considering factors including the
assumptions on which it rests, and the costs and benefits of
specialization (a full discussion must take into account
arguments in favour and against free trade and protection—
see below).
1. Describe the differences between
countries in in terms of factor endowments
and the levels of technology.
Costs of production varies between countries
because of “factor endowments” – types of factors of
production a country is “gifted” with.
For example, New Zealand has a large land mass with
volcanic soil, undulating landscapes with moderate
temperatures and much rainfall – very conducive to
growing fruits and vegetables. This also gives rise to
lots of green grass when the trees got cleared; hence
this allows for plenty of sheep and cattle raising –
making for huge wool, meat and dairy industries.
2. Explain the theories of absolute and
comparative advantage and illustrate each
by a sketch PPC diagram.
Meat
(pounds)
Potatoes (pounds)
3. Calculate opportunity costs from a set of
data in order to identify comparative
advantage and illustrate on a diagram.

Imagine . . .
only two goods: potatoes and meat
only two people: Mr. Jones and Mrs. Choi

Will they be better off if they trade?
Who is most efficient at each product?
Would you think there’s a good reason to trade?
Jones
Choi
Hours Needed to Make 1 lb. of:
Meat
Potatoes
20 hours/lb
10 hours/lb
10 hours/lb
8 hours/lb.
Amount Produced in 40 Hours
Meat
Potatoes
2 lbs.
4 lbs.
4 lbs.
5 lbs.
The producer that requires a smaller quantity of
inputs (in this case, hours of labour) to produce a
good is said to have an absolute advantage in
producing that good. Does that mean Mrs. Choi
has no reason to trade?
Consider Mr. Jones’ Production – and
consumption – Possibilities Frontier
Meat
(pounds)
2
1
0
A
2
4
Potatoes (pounds)
Mrs. Choi’s Production – and consumption –
Possibilities Frontier
Meat
(pounds)
4
B
2
0
2.5
5 Potatoes (pounds)
Compare the Opportunity Cost for each person
producing Meat and Potatoes
1 lb. of Meat
1lb. Of Potatoes
Mr. Jones
2 lb. potatoes
0.5 lb. meat
Mrs. Choi
1.25 lb. potatoes
0.8 lb. meat
The producer who has the smaller opportunity cost
of producing a good is said to have a comparative
advantage in producing that good.
Who has the comparative advantage for
a) meat
b) potatoes?
The Gains from Trade:
Suppose the “terms of trade” is 0.66 Lbs. of meat = 1 Lbs. of Potatoes
[see the table for how much each person has gained]
Can you show the new “consumption frontier” for each person?
That’s why it’s good to trade even for Mrs. Choi!
The Outcome With Trade:
What They
What They
Trade
Produce
What They
Consume
1.3 lbs meat (A*)
2 lbs potatoes
Jones
0 lbs meat
4 lbs potatoes
Gets 1.3 lbs meat
for 2 lb potatoes
Choi
4 lbs meat
0 lbs potatoes
Gives 1.3 lbs meat 2.7 lbs meat (B*)
2 lbs potatoes
for 2 lb potatoes
4. The Limitations of the Theory
1.
2.
3.
4.
Transport costs and tariffs will change the relative prices of
goods and may therefore 'blur' the impact of comparative
advantage.
Exchange rates do not always relate exactly to what
comparative advantage theory suggests as they have many
other determinants - this may also negate the theory.
Imperfect competition may lead to prices being different to
opportunity cost ratios. Imperfect competition may also lead to
the exploitation of economies of scale which may adjust to
what comparative advantage theory suggests should happen.
Comparative advantage theory is a static theory and does not
take account of some of the more dynamic elements
determining world trade. In particular, the factor of production
capital is not a natural resource, and so may come outside the
scope of the theory.