Comparative Advantage

Teng, J
 Trade and Comparative
Advantage
 The production possibility curve is
bowed because individuals specialize
in the production of goods for which
they have a comparative advantage
and trade with others.
 Refer to the meat and potato example
of the last lecture.
 Trade and Comparative
Advantage
 To produce on the production
possibilities curve, individuals must
produce those goods for which they
have a comparative advantage.
Markets, Specialization, and
Growth
 The growth in per capita income in
the past two millennia has been
astonishing.
 This owes largely to the introduction
of markets.
Markets, Specialization, and
Growth
 Markets allow specialization, leading
to trade and growth.
Markets, Specialization, and
Growth
 As people are allowed to compete and
specialize, they get better at what
they do, develop new technologies,
and the market grows ever larger.
 Growth in the Past Two
(in 1990 international dollars) Millennia

$6,000
Per capita income

$5,000
$4,000
$3,000
$2,000
$1,000

0 500 1000 1500 2000

 The Benefits of Trade

 When people trade, both parties

expect to benefit from the trade.
 Otherwise, why would they have
traded in the first place?
 The Benefits of Trade

 The argument for the benefits of

trade underlies the general policy of
laissez-faire.
 Laissez-faire – an economic policy of
leaving coordination of individuals’
actions to the market.
 Production Possibilities
without Trade
 Pakistan can produce 4,000 yards of
textile per day or 1 ton of chocolate
per day.
 Belgium can produce 1,000 yards of
textile a day or 4 tons of chocolate
per day.
 Production Possibilities
without Trade
 Pakistan has a comparative
advantage in producing textiles.

 Belgium has a comparative

advantage in chocolate.
 Production Possibilities
(in thousands of yards)
without Trade

5
4
Pakistan
Textiles

2
Belgium
1

1 2 3 4 5
Chocolate (in tons)
 Production Possibilities
without Trade
 Pakistan has chosen to produce 2,000
yards of textiles and 0.5 tons of
chocolate.
 Belgium has chosen to produce 500
yards of textile and 2 tons of
chocolate.
 Production Possibilities
without Trade
 Point A: The combination of textile
and chocolate chosen by Pakistan.

 Point B: The combination of textile

and chocolate chosen by Belgium.
 Point C: The joint combination
without trade.
 Production Possibilities
without Trade
Pakistan’s and Belgium’s Individual Possibilities
Textile per day Chocolate per day

Pakistan 2,000 yards 0.5 ton

Belgium 500 yards 2 tons
Total 2,500 yards 2.5 tons
 Production Possibilities
(in thousands of yards) without Trade

5
4
Textiles

Pakistan
3 C
A
2
Belgium
1 B

1 2 3 4 5
Chocolate (in tons)
 Production Possibilities
without Trade
 The two extreme combinations are
both countries producing only
textile (point D) and both
producing only chocolate (point E).

 The combined production possibilities

curve with no trade is drawn by
connecting these two points.
 Production Possibilities
without Trade

D
(in thousands of yards)

5
4
Textiles

Pakistan
3 C Joint (no trade)
A
2
Belgium
1 B
E
1 2 3 4 5
Chocolate (in tons)
Production Possibilities with
Trade
 Point F: This is where each nation is
focusing on that activity for which it
has a comparative advantage.
 Pakistan produces 4,000 yards of textile.
 Belgium produces 4 tons of chocolate.
Production Possibilities with
Trade

Combined Production Possibilities

Specializing Gains to
No Trade
and Trade Trade
Fabric 2,500 yards 4,000 yards 1,500 yards
Chocolate 2.5 Tons 4 tons 1.5 Tons
Production Possibilities with
Trade

D Gains from trade

(in thousands of yards)

5 Joint (with trade)

4 F
Textiles

3 C Joint (no trade)

2

1
E
1 2 3 4 5
Chocolate (in tons)
Production Possibilities with
Trade
 The combined PPC is bowed out
because of Point F – comparative
advantage and specialization.
 U.S. Textile Production and
Trade
 Two hundred yeas ago, the U.S had a
comparative advantage in textile
production.
 Now, countries with cheaper labor,
such as Bangladesh have the
comparative advantage in textile
production.
 U.S. Textile Production and
Trade
 The gains from trade show up as
higher pay for workers in Bangladesh
and lower-priced cloth for U.S.
consumers.
 Comparative vs. Absolute
Advantage
An individual has a comparative
advantage in producing a good or service if
the opportunity cost of producing the good is
lower for that individual than for other
people.
An individual has an absolute advantage
in an activity if he or she can do it better
than other people. Having an absolute
advantage is not the same thing as having a
comparative advantage.
Production Possibilities Curve (Farmer)

(a) The Farmer ’s Production Possibilities Frontier

Meat (ounces)

If there is no trade,
the farmer chooses
8 this production and
consumption.

4 A

0 16 32 Potatoes (ounces)

Copyright©2003 Southwestern/Thomson Learning

The Production Possibilities Curve (Ranger)

(b) The Rancher ’s Production Possibilities Frontier

Meat (ounces)

24

If there is no trade,
the rancher chooses
this production and
consumption.

12 B

0 24 48
Potatoes (ounces)

Copyright©2003 Southwestern/Thomson Learning

Farmer has no Absolute
Advantage in Anything
Comparative Advantage and International
Trade (Ex.: The U.S. Economy)
Comparative Advantage and International
Trade (Ex.: The Canadian Economy)
 PITFALLS: Misunderstanding
Comparative Advantage
A common mistake is to confuse comparative advantage
with absolute advantage.
Ex.: U.S. vs. Japan in 1980s
Commentators: “U.S. might soon have no
comparative advantage in anything”
Wrong! They meant “absolute advantage”
 Summing up
 Specialization leads to higher
production
 Everyone has different Opportunity
costs, everyone has comparative
advantage/disadvantage in
something.
 It is comparative and not absolute
advantage the basis for mutual gain.