# 06 COMPARATIVE ADVANTAGE _2 - SECTION 6 COMPARATIVE...

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THEORY OF COMPARATIVE ADVANTAGE Specialization and free trade benefit all trading parties Both trading partners can gain by specializing in what they do best and trading with each other
ABSOLUTE ADVANTAGE Person A or Country A has an absolute advantage over Person B or Country B in the production of a given item if, by using a given amount of resources, Person A or Country A can produce more of the given item than Person B or Country B. Thus, Country A is “better” at producing the item. Country A is “more efficient”.

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COMPARATIVE ADVANTAGE A situation in which a person or country can produce a good at a lower opportunity cost than another person or country
EXAMPLE: Suppose the US and China both produce cell phones and calculators. Suppose in China, in one day, workers can produce 2,000 cell phones or 8,000 calculators. The PPF for China is shown in Graph 1.

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Comparative Advantage Graph 1 Cell Phones v. Calculators China 0 500 1000 1500 2000 2500 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 China Calculators China Cell Phones OC (cell) = 8,000/2,000 = 4.0 calculators OC (calc) = 2,000/8,000 = 0.25 cell phones
Suppose in the US, in one day, workers can produce 1,600 cell phones or 2,000 calculators. The PPF for the US is shown in Graph 2.

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Comparative Advantage Graph 2 Cell Phones v. Calculators United States 0 400 800 1200 1600 2000 0 1000 2000 3000 4000 5000 6000 7000 8000 USA Calculators USA Cell Phones OC (cell) = 2,000/1,600 = 1.25 calculators OC (calc) = 1,600/2,000 = 0.80 cell phones
China has an absolute advantage over the US when producing cell phones. China has an absolute advantage over the US when producing calculators. In this example, China is “better” than the US at everything.

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To illustrate how both countries can benefit by specializing and trading with each other, start by drawing the PPF’s for each country. Let variable Y = cell phones Let variable X = calculators For simplicity, assume constant opportunity cost in each country, so the PPFs are straight lines. Assume that the US and China both produce efficiently, so each country is ON, rather than inside, its PPF.
Now pick a point on each country’s PPF to illustrate each country’s preferred output selection. Suppose China produces 500 cell phones and 6,000 calculators. Note that this is a point on the China PPF in Graph 1. For example, suppose the US chooses to produce 800 cell phones and 1,000 calculators. Note that this is a point on the US PPF in Graph 2.

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Without specialization and trade, neither country can move outside its PPF. For China, it is possible that consuming 500 cell phones and 6,000 calculators is preferred to some points that are outside the PPF. But any point OUTSIDE its PPF where China has at least 500 cell phones and at least 6,000 calculators is definitely preferred to the original point.
and 1,000 calculators is preferred to some points that are outside the PPF. But any point OUTSIDE its PPF where the

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06 COMPARATIVE ADVANTAGE _2 - SECTION 6 COMPARATIVE...

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