1. ECONOMIC PRINCIPLES Comparative Advantage
CIVICS
Mr. Hensley
SRMHS
In Day 2, we take the concept of opportunity cost a step further and define both absolute and comparative advantage.

2. Should I Clean My Own House?
I can hire a professional to do it for $20/hour
It will take them 4 hours (it would take me 5)
They will do a better job
Perform a cost-benefit analysis (I think my time is worth $30/hour)
How little does my time have to be worth for this NOT to make sense?
If you think it through, it makes sense. Imagine I can earn $30 by, say writing and selling my lesson plans. Should I spend 5 hours of my life cleaning my house? If I do, I’ve lost 5 hours of time in which I could have earned $150. I’d be better off hiring a cleaner – they could get it done in just four hours at a cost of $20 an hour (or $80 total). I could spend $80 and free myself up to earn $150. Or.. I could do it myself and save $80 – but at the cost of $150 in lost income. Clearly, I’m better off hiring the cleaner. However, if my time goes down to $15 an hour, I’d be better off doing it myself (5 hours at $15 an hour is $75 in lost wages versus the cost of $80 I’d get for hiring the cleaner).

3. Absolute Advantage
One person has an absolute advantage over another if they need less time to perform a task
In the previous example, the cleaner has an absolute advantage over me in house cleaning (4 hours versus 5 hours)
The person with the absolute advantage can produce more in the same amount of time
In my example, the cleaner has an absolute advantage over me in that they can clean the house faster than I can (4 hours versus five for me). But note, my decision to hire the cleaner occurred because the opportunity cost of cleaning the house myself ($150 in lost earnings) was better than the $80 cost of hiring the cleaner. It had nothing to do with whether or not the cleaner was faster than me – it had everything to do with opportunity cost.

4. Comparative Advantage
The person with the comparative advantage has a lower opportunity cost
If I clean my house, my opportunity cost is $150 (my time is worth $30/hour)
The cleaner’s opportunity cost is less than or equal to $20/hour – their opportunity cost is lower than mine
The person with the lower opportunity cost is said to have the comparative advantage and in making economic decisions, we should use comparative advantage and opportunity cost to guide us, not absolute advantage.

5. Always Go with Comparative Advantage
My wife can clean the house in only three hours (she’s fast!)
Her time is also worth $30/hour
She has an absolute advantage over the cleaner – but the cleaner still has the comparative advantage over her
Go with the cleaner!
We can change the scenario to give a new person (my wife in this example) the absolute advantage regarding housework (she is faster than the cleaner). But given my wife’s opportunity cost of her time, it still makes more sense to go with the cleaner and their comparative advantage.

6. Break It Down Who’s Cleaning? Explicit Cost Opportunity Cost
Total Cost
Mr. Hensley
Zero
$150
The Cleaner
$80
n/a
Mrs. Hensley
$90
The table demonstrates the overall cost of each option. Note that the cleaner results in the lowest cost. For the cleaner, we assume their opportunity cost must be less than $20 an hour or they wouldn’t be willing, as rational people, to work for $20 an hour if they had better-paying opportunities available.

7. Another example of comparative advantage
Another example of comparative advantage. Even if Pam the lawyer was better at secretarial work than Ann, it would still make more sense for Pam to stick to lawyer work, as she gives up $150 an hour in earnings if she does anything else. Ann could be five times slower on secretarial work than Pam and it would still make sense for Pam to be the lawyer and Ann to be the secretary.

8. Tom and Hank on a Deserted Island
Here, we are going to introduce a very simple mode. Two men, Tom and Hank, share a desert island. The only two activities possible are fishing or gathering coconuts. For Tom, if he does nothing but fish, he can gather 40 fish a day. If he only gathers coconuts, he can get 30. Or, he can get any possible combination of fish and coconuts along the line that connects 30 coconuts to 40 fish. The line is called the “production possibility frontier”. Any point along that line represents Tom using all his time (it is “efficient”). Any point inside the line means that Tom isn’t working as hard as he could be working (it is inefficient). Any point outside the line, is simply not possible.

9. Hank Has NO Absolute Advantage
Here is Hank’s production possibility graph. Note that Tom has an absolute advantage over Hank in both coconuts (30 over Hank’s 20) and fish (40 over Hank’s ten).

10. Tom and Hank’s Opportunity Costs
Tom’s Opportunity Cost
Hank’s Opportunity Cost
One fish
3/4 coconut
2 coconuts
One coconut
4/3 fish
1/2 fish
Since there are only two resources on the island, we can express the price of each resource in terms of the other. For Tom, every time he gets an extra fish, he is giving up the chance to get three-fourths of a coconut. Every time Tom gets an extra coconut, he is giving up four-thirds of a fish. Note that Tom gives up fewer potential coconuts to get an extra fish compared to Hank. We could say that Tom has a lower opportunity cost for fish or that Tom has the comparative advantage over Hank in fishing. Hank, on the other hand, has a lower opportunity cost and thus the comparative advantage in gathering coconuts.

11. Specialize and Trade
Both castaways are better off when they each specialize in what they are good at and trade.
It’s a good idea for Tom to catch the fish for both of them, because his opportunity cost of a fish in terms of coconuts not gathered is only 3⁄4 of a coconut, versus 2 coconuts for Hank.
Correspondingly, it’s a good idea for Hank to gather coconuts for the both of them.
We should follow the principle of comparative advantage and let the person with the comparative advantage gather the resource for which they have the lowest opportunity cost. This means fishing for Tom and gathering coconuts for Hank.

12. Tom’s Comparative Advantages
Following their comparative advantage and specializing in one resource, Tom and Hank can trade their surplus. This results in Tom (pictured here) being able to achieve consumption that is outside (greater than) his production possibility frontier.

13. Hank’s Comparative Advantages
With Hank, the advantages are even bigger than were Tom’s. Both Tom and Hank are demonstrably better off through specializing through the principle of comparative advantage and then trading with each other. They achieve more through specialization and trading than they ever could alone.

14. The Gains from Trade Both Tom and Hank experience gains from trade:
Tom’s consumption of fish increases by two, and his consumption of coconuts increases by one.
Hank’s consumption of fish increases by four, and his consumption of coconuts increases by two.
Through specialization and trade, Tom and Hank gain access to 6 extra fish and 3 extra coconuts. We call this the “gains from trade”.