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Wize University Macroeconomics Textbook > Gains from Trade

Absolute & Comparative Advantage

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Absolute and Comparative Advantage

In this section we see the difference between absolute advantage and comparative advantage to understand why countries benefit from trading with each other.

Absolute Advantage

To have an absolute advantage means the ability to produce a good using fewer inputs (less time, workers, money) than another producer. It can also be seen as the ability to make more goods in the same amount of time.
CANADA MEXICO
SHOES 40,000 90,000
BOOKS 4,000 6,000
The schedule above shows the maximum amount of two goods that can be made in a year in each country.
  • Mexico
    has an absolute advantage in shoes because they can make more shoes in the same amount of time.
  • Mexico
    has an absolute advantage in books because they can make more books in the same amount of time.

Production Possibility Curve (PPC)

  • Production Possibility Curve (PPC) - a line that shows the different combinations of two products that can be produced
  • Consumption Possibility Curve (CPC) - the same as the PPC but it shows the combinations of two products that can be consumed with trade.



Opportunity Cost

The opportunity cost is how much of one good must be given up to make one more unit of another good.
Opportunity Cost for Canada
  • In the diagram above, the opportunity cost of making one book for Canada is
    40000/4000 = 10
    shoes.
  • The opportunity cost of making one shoe for Canada is
    4000/40000 = 0.1
    books.
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Opportunity Cost for Mexico
  • The opportunity cost of making one book for Mexico is
    90000/6000 = 15
    shoes.
  • The opportunity cost of making one shoe for Mexico is
    6000/90000 = 0.067
    books.

Comparative Advantage

  • Comparative Advantage – this is when you have a lower opportunity cost of producing a product.
  • Canada
    has a comparative advantage in books because they have a lower opportunity cost of making books.
  • Mexico
    has a comparative advantage in shoes because they have a lower opportunity cost of making shoes.
  • This means Canada will specialize all their time in making books and then
    export
    books to Mexico and
    import
    shoes from Mexico










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Example: Absolute and Comparative Advantage

Suppose you are provided with the per unit cost of production below:

Germany (Euros) France (Euros)

Generators 10,000 15,000
Wine 10 30


Germany
has an absolute advantage in Generators
Germany
has an absolute advantage in Wine
France
has a comparative advantage in Generators
Germany
has a comparative advantage in Wine









Practice: Absolute and Comparative Advantage

Cotton Cocoa Beans
Peru 2 4
Brazil 1 6

Refer to the table above that shows the amount of each product that the two countries can produce with one worker. Compared with Peru, Brazil has: