Comparative Advantage, Absolute Advantage, Specialization and Trade When an individual or nation specializes in the production of a particular good or service and trades for all other goods or services, the total output and welfare of a society is increased.

Absolute Advantage A country has an absolute advantage in the production of a good when it can produce it using fewer resources than another country or individual. For example. If the USA can produce 13 million cell phones using 1,000 workers and Korea can produce only 12 million using 1,000 workers, the USA has an absolute advantage in the production of cell phones. If the USA can grow 39 million apples using 1,000 workers and Korea can grow on 24 million apples using the same amount of labor, then the USA has an absolute advantage in apples.

Absolute Advantage in a Production Possibility Table Country/Good Cell Phones Produced by 1,000 Workers (millions) Apples Grown by 1,000 Workers (millions) USA 13 39 Korea 12 24

Comparative Advantage A country has a comparative advantage in production of a certain product when it can produce that product at lower relative opportunity cost than another country. To determine which country has a comparative advantage in apples, you must calculate the opportunity cost of apples in the USA and in Korea.

Comparative Advantage Explained To grow 39 million apples, the USA must give up 13 million cell phones. Therefore each apple costs the USA 13 39 = 0.33 cell phones. To grow 24 million apples in Korea, 12 million cell phones must be given up. Each apple costs Korea 12 24 =0.5 cell phones. So the opportunity cost of an apple in the USA is only 0.33, while the opportunity cost of an apple in Korea is 0.5 cell phones. It cost the USA fewer cell phones to produce apples so the USA has the comparative advantage.

Comparative Advantage in Cell Phones To determine which country has a comparative advantage in cell phones, you must calculate the opportunity cost of cell phones in the USA and Korea. To produce 13 million cell phones, the USA gives up 39 million apples . Each cell phone costs 39 13 = 3 apples. To produce 12 million cell phones, Korea gives up 24 million apples, so each cell phone costs Korea 24 12 =2 apples. The opportunity cost of cell phones is lower in Korea than the USA. So Korea has the comparative advantage in the production of cell phones, because it costs Korea fewer apples to make the cell phone.

Keep In Mind A country could never have a comparative advantage in production of both goods, because the opportunity cost of one good is the reciprocal of the other good.

Specialization and Trade Should always be based on comparative advantage, not absolute advantage. Countries should specialize in the production of the good(s) for which they have a comparative advantage over other countries, and trade for the goods they do not. This type of trading allows each country to reduce its opportunity cost of the good it imports. Korea should specialize in the production of cell phone while the USA specializes in growing apples, and the two countries should trade with one another.

Keep in Mind Both countries can benefit from trade by taking advantage of the other country’s lower opportunity cost for the good in which it specializes. For example: Assume the two countries specialize and trade with one another at a rate of 2.5 apples per cell phone, or 0.4 cell phones per apple. The USA gains from the trade because domestically, each cell phone would have cost three apples, but with trade the USA only gives up 2.5 apples per cell phone. Korea gains from trade because domestically, each apple would have cost 0.5 cell phones, but with trade it only gives up 0.4 cell phones 1 25 per apple.

Give It A Try Fish Wheat Country A 10 labor-hours 20 labor-hours Country B 60 labor-hours The table above indicates labor hours needed to produce a single unit of each of two commodities in each of two countries. If labor is the only factor used to produce the commodities, which of the following statements must be correct? Country A has an absolute advantage in the production of both commodities, but a comparative advantage in the production of wheat. Country B has an absolute advantage in the production of both commodities, but a comparative advantage in the production of fish. Mutually advantageous trade can occur between the two countries when 2.5 units of fish are exchanged for 1 unit of wheat. I only D. I and III only II only E. II and III only III only