Comparative Advantage

1
Comparative Advantage

• Quick Introduction

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Brief History

• David Ricardo introduces the concept of
  comparative advantage in 1819 (On the Principles
  of Political Economy and Taxation. London John
  Murray, 1819.)
• Important because
• Shows that it is optimal for countries to
  specialize and trade
• Show that EVERY country has a comparative
  advantage at something

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Absolute advantage

• Absolute advantage came before Ricardo proved
  that
• every country has a comparative advantage in
  something
• and everyone is better off if each country
  specializes in the product for which it has a
  comparative advantage
• Absolute advantage in a good means that fewer
  resources (labor, energy) are used to produce a
  unit of that good relative to another country.

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Absolute Advantage
Resources to produce 1 computer 1 shirt
US 10 20
Mexico 20 5
5
Absolute Advantage
Resources to produce 1 computer 1 shirt
US 10 20
Mexico 20 5

• The US is better than Mexico at producing
  computers (uses fewer resources). So the US has
  an absolute advantage in computers.
• Mexico uses fewer resources than the US to
  produce shirts. Mexico has the absolute
  advantage in shirts.

6
Absolute Advantage
Resources to produce 1 computer 1 shirt
US 10 20
Mexico 20 5

• The US should specialize in computers.
• Mexico should specialize in shirts.

7
Comparative advantage
Resources to produce 1 computer 1 vaccine
US 5 10
Mexico 20 20
8
Comparative advantage
Resources to produce 1 computer 1 vaccine
US 5 10
Mexico 20 20

• US is better at both computers and vaccines. US
  has the absolute advantage in both.
• Should countries still specialize?

9
Comparative advantage
Resources to produce 1 computer 1 vaccine
US 5 10
Mexico 20 20

• Should countries still specialize?
• Yes, countries should specialize. The country
  with a comparative advantage in computers should
  produce computers. The country with a
  comparative advantage in vaccines, should produce
  vaccines.

10
Opportunity cost

• Opportunity cost is the best alternative an
  economic agent has when she makes a choice.

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Comparative Advantage

• To identify a countrys comparative advantage in
  a product, we compare opportunity costs for the
  product across the two countries.

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Comparative advantage
Resources to produce 1 computer 1 vaccine
US 5 10
Mexico 20 20

• Who has the comparative advantage in computers?
  (i.e., who has the lowest opportunity cost for
  producing computers?)
• What is the US opportunity cost for computers?
  (How many vaccines does the US give up to produce
  1 computer?)
• What is Mexicos opportunity cost for computers?
  (How many vaccines does Mexico give up to produce
  1 computer?)

13
Comparative Advantage

• A comparative advantage in a good is a lower
  opportunity cost for producing that good.