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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 By using a given amount of resources, a person or country can produce more of a given item than another person or country can produce

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COMPARATIVE ADVANTAGE A person or country can produce a good or service at a lower opportunity cost than another person or country
EXAMPLE: Suppose the US and China both produce computers and clothes Suppose in the US, in one day, a worker can produce 40 computers or 80 suits Suppose in China, in one day, a worker can produce 10 computers or 40 suits

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A US worker has an absolute advantage over a Chinese worker when producing computers US = 40 computers per day China = 10 computers per day A US worker has an absolute advantage over a Chinese worker when producing clothes US = 80 suits per day China = 40 suits per day US is “better” than China at everything Is there any reason for these two to trade?

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OPPORTUNITY COST For simplicity, assume constant opportunity cost in each country Let variable Y = computers Let variable X = suits For the US, the opportunity cost of 40 computers is 80 suits The slope of the PPF = (-40/80) = -.0.5 That is, to get 1 additional suit, US must give up 0.5 units of computers; (i.e. ½ of a computer)

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For China, the opportunity cost of 10 computers is 40 suits The slope of the PPF = (-10/40) = -0.25 That is, to get 1 additional suit, China must give up 0.25 units of computers; (i.e. ¼ of a computer)
COMPARATIVE ADVANTAGE Opportunity cost of 1 more suit US must give up ½ of a computer China must give up ¼ of a computer

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China has a comparative advantage in the production of suits because China has a lower opportunity cost than the US in the production of suits.
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