Comparative & Absolute Advantage
Comparative Advantage: The ability to produce something at a lower opportunity cost than other producers face Absolute Advantage: The ability to produce something with fewer resources than other producers use
Brazilian
8
10 pounds Coffee
Suppose, for example, that a lawyer whose fees run $250 an hour types twice as fast as her secretary, whose wage is $12 hourly. She still gains by hiring the secretary. Despite her absolute advantage in typing, the lawyer’s comparative advantage lies in practicing law.
Babe Ruth
Opportunity cost is the key to comparative advantage: Individuals and nations gain by producing goods at relatively low costs and exchanging their outputs for different goods produced by others at relatively low cost. All potential trading partners can gain enormously through appropriate specialization and exchange.
Production 10 pounds Salmon Consumption 5 pounds of salmon 5 pounds of coffee 5 pounds of coffee 5 pounds of salmon
4 4 4 4
Hours Worked 8
Brazilian
After Specialization Alaska
Opportunity Cost
The Next Best Alternative
The Opportunity Cost of doing something is the value of the next best alternative you give up.
What is the opportunity cost of investing $500 in a new stereo system? What is the opportunity cost of going to college?
Comparative Advantage in Early America
“Cash crops did not grow well in the Northern soil
Opportunity cost varies from person to person
What would you have purchased if you did not purchase the $500 stereo system? What could you “earn” if you don’t go to college
Opportunity Costs and Efficiency
Before Specialization Alaskan Hours Worked Production and Consumption 5 pounds of salmon 1 pound of coffee 1 pound of salmon 5 pounds of coffee
How do you get an A in this class?
Of course, hard work nd fulfilling requirements If you are unable to achieve an A by fulfilling requirements, you may be able to buy one. The going rate is one million dollars
How do individuals or groups determine which specific goods or services to produce?
Law of Comparative Advantage
The individual (or country) with the lowest opportunity cost of producing a particular good should specialize in producing that good. Specialization – The concentration of the productive efforts of individuals and firms on a limited number of activities
When we use resources to produce one good or service, the opportunity cost is that we cannot produce another good or service.
When we make birdcages, we cannot use the same resources to make chairs.