Comparative and Absolute advantage

COMPARATIVE ADVANTAGE THINK OF a town’s best lawyer who is also its best typist. Provided that she is better at law than at typing, she should specialize in law and leave her secretary to do the typing. That way, both of their earnings will be higher. The same logic applies to countries. Each country should specialize in producing those things that it produces most efficiently, rather than producing a bit of everything, because that way its income will be higher.

Comparative Advantage When a country can produce a good or service at a lower opportunity cost than another country Even if absolute disadvantage exists for a country, it can still benefit its neighbours with trade by focusing on the good with a lower opportunity cost than theirs (they give up less than the other country)

Comparative Advantage & PPF Corn Wheat Because the PPF gradients are different, these two countries have different opportunity costs between Corn and Wheat  they will trade! **Opportunity cost = sacrifice/gain Country X Country Y The opp. cost of Country Y producing wheat is 6/5 (sacrifice over gain) The opp. cost of Country X producing wheat is 9/6 So, Country X should do the wheat (lower opportunity cost)

Comparative Advantage & PPF Corn Wheat Because the PPF gradients are the same, these two countries have the same opportunity costs between Corn and Wheat  they will not trade! * Country X MAY have an absolute advantage, or it may just have more resources. Country X Country Y

Absolute Advantage When it is possible for one country to produce more goods and services than other countries with the same level of inputs (lower cost/unit) Eg. Zambia has large reserves of copper ore  is better suited to produce copper for export This is not main reason for international trade

Information Annie and Bertie are siblings who have just thoroughly enjoyed a week at home in the school holidays without their parents; there have been parties and sleepovers every night. However, their parents are due to return later in the day, and there is a large amount of cleaning and tidying to do! Luckily, the friends of Annie and Bertie have helped out with most tasks, but they have all gone home, leaving Annie and Bertie with just the vacuum-cleaning and washing-up to do. There are 12 rooms to vacuum, and 8 sink loads of washing-up to do. The following table shows their hourly work-rate: Question Set 1 1 How long would it take a) Annie and b) Bertie, to do the vacuuming? Who is better at vacuuming? 2 How long would it take to do the vacuuming if Annie and Bertie worked together (assuming there is more than one vacuum cleaner in the house!)? 3 How many minutes would it take a) Annie and b) Bertie to vacuum one room? How many minutes would it take if they worked together? 4 How long would it take a) Annie and b) Bertie to do the washing up? Who is better at washing up? 5 How long would take to do the washing up if they both worked together? 6 How many minutes would be take a) Annie and b) Bertie to wash up one sink load of dirty dishes? How many minutes would it take if they worked together?

Comparative Advantage Question Set 2: Read each of the possible options below and answer the accompanying questions in order to establish the best option for Annie and Bertie. Issues for discussion: 1 What assumptions have been made in this activity? Consider aspects such as constant productivity, the ability to actually measure output, freely available factors of production etc 2 What is the difference between absolute and comparative advantage? How does this tie in with international trade? Calculate the opportunity costs associated with the different levels of output by Annie and Bertie – how does this tie in comparative advantage? 3 Why might Annie and Bertie decide to share the tasks, despite the fact that it is less economically efficient? Explore the reasons why countries may decide not to specialise in production of just one good

What Determines Comparative Advantage? Comparative advantage is a dynamic concept meaning that it can and does change over time. For a country, the following factors are important in determining the relative costs of production: 1.The quantity and quality of factors of production available 2. Investment in research & development which can drive innovation and invention 3. Fluctuations in the real exchange rate, which then affect the relative prices of exports and imports and cause changes in demand from domestic and overseas customers.exchange rate 4. Import controls such as tariffs, export subsidies and quotas – and other forms of protectionism – these can be used to create an artificial comparative advantage for a country's domestic producers.tariffs 5. The non-price competitiveness of producers - covering factors such as the standard of product design and innovation, product reliability, quality of after-sales support.

Comparative advantage is often a self- reinforcing process. Entrepreneurs in a country develop a new comparative advantage in a product either because they find ways of producing it more efficiently or they create a genuinely new product that finds a growing demand in home and international markets Rising demand and output encourages the exploitation of economies of scale; higher profits can be reinvested in the business to fund further product development, marketing and a wider distribution network. Skilled labour is attracted into the industry and so oneconomies of scale

Homework Research 5 countries and the comparative advantage they have.