Calculating absolute and comparative advantage

Overview

Single most important difference between absolute and comparative advantage and standard comparative advantage model assume constant opportunity costs.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does it mean to say a country has an absolute advantage in producing a good?

   Model answer

   A country has an absolute advantage in a good when it can produce more of that good than another country from the same quantity of resources, or equivalently when it can produce a unit of the good using fewer resources. It is a comparison of productivity levels between countries in one good, and it says nothing on its own about what a country should specialise in.

2. 2

   What does it mean to say a country has a comparative advantage in producing a good?

   Model answer

   A country has a comparative advantage in a good when it can produce that good at a lower opportunity cost than another country, where the opportunity cost is the quantity of the other good given up to make one more unit. Comparative advantage is a comparison of internal trade-offs across countries, not of productivity levels.

3. 3

   State the single most important difference between absolute and comparative advantage.

   Model answer

   Absolute advantage compares how much output each country gets from its resources; comparative advantage compares what each country must give up to obtain that output. Absolute advantage is measured in units of output or units of input, while comparative advantage is measured as a ratio of one good against the other. Only comparative advantage determines the pattern of mutually beneficial trade.

4. 4

   Can one country hold an absolute advantage in every good it produces? Can it hold a comparative advantage in every good?

   Model answer

   A country can hold an absolute advantage in every good, because it may simply be more productive across the board. It cannot hold a comparative advantage in every good, because opportunity cost ratios are reciprocal: if one country gives up less of good B per unit of good A, then by arithmetic the other country must give up less of good A per unit of good B. Comparative advantage is therefore shared out between trading partners whenever their opportunity cost ratios differ at all, and only where the ratios are identical does neither country hold one.

5. 5

   Northland can produce, per worker per year, either 20 tonnes of wheat or 10 metres of cloth. Southland can produce, per worker per year, either 8 tonnes of wheat or 8 metres of cloth. Which country has an absolute advantage in each good?

   Model answer

   Northland has an absolute advantage in both goods. In wheat it produces 20 tonnes per worker against Southland's 8, and in cloth it produces 10 metres per worker against Southland's 8. Southland has an absolute advantage in nothing, yet this does not rule out gains from trade.

6. 6

   Northland can produce, per worker, either 20 tonnes of wheat or 10 metres of cloth; Southland can produce, per worker, either 8 tonnes of wheat or 8 metres of cloth. Calculate each country's opportunity cost of one metre of cloth and of one tonne of wheat.

   Model answer

   For Northland, one metre of cloth costs 20 divided by 10, which is 2 tonnes of wheat, and one tonne of wheat costs 10 divided by 20, which is 0.5 metres of cloth. For Southland, one metre of cloth costs 8 divided by 8, which is 1 tonne of wheat, and one tonne of wheat costs 8 divided by 8, which is 1 metre of cloth. The ratios are reciprocals within each country.

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