hi everybody Jacob Reed here from review econ.com today we're going to be talking about comparative advantage comparative advantage allows us to use specialization and trade to make us better off if after watching this video you still need a little more help head over to review econ.com and pick up the total review booklet it has everything you need to know to Ace your microeconomics or macroeconomics AP exams now let's get into the content so before we get into comparative advantage let's talk about absolute advantage and to do that we're going to look at these two countries big country and little country of course countries can make all kinds of different Goods but we're going to simplify this and assume that they can make just two goods meet and grain Big Country if they put all of their resources towards the production of grain they can produce 80 tons of grain if they put all their resources towards the production of meat on the other hand they will have 40 tons of meat little country on the other hand if they put all of their resources towards the production of grain we'll have 20 tons of grain and if they put all of their resources towards the production of meat they will have 20 tons of meat if we put these numbers on production possibilities curves big countries production possibilities curve would look something like this while little country's production possibilities curve would look something like this now absolute Advantage is the ability to produce more of something with fixed resources or the same amount of something with fewer resources so essentially absolute Advantage is who's better at the production of a particular good back to our table and grab apps here who has the absolute advantage in the production of grain so if we Compare the numbers we have for these two countries in the production of grain on the table or the graph we can see that big country has the absolute advantage in the production of grain and that's because 80 tons is greater than 20 tons when it comes to the absolute Advantage for the production of meat on the other hand big country can produce 40 tons and little country can produce 20 tons once again big country has the absolute Advantage here because 40 tons is greater than 20 tons now absolute Advantage is something you need to know on the AP microeconomics and macroeconomics exams but what's more important in economics is comparative advantage comparative advantage is the ability to produce something at a lower opportunity cost and as you may have already learned opportunity cost is what you give up when you make a choice in this case we're looking at the opportunity cost for the production of grain or meat and this is how we determine the best use of resources in production of products let's take a look at these numbers again here these numbers that we have in the chart are finished products we have tons of grain and tons of meat that means this is an output problem the numbers in the table are outputs and when it comes to Output problems the formula for opportunity cost is the other over formula that means the opportunity cost for producing one unit of good a is the numbers we have for the other one good B divided by the Numbers we have for good a let me show you what I'm talking about first let's take a look at big country and their opportunity cost us for producing grain so the opportunity cost of grain is the numbers we have for the other one meat 40 tons divided by the Numbers we have for grain 80 times reduce that fraction down and it gives us half a ton of meat being our opportunity cost for producing one ton grain but when Big Country on the other hand produces one ton of meat we're going to take the numbers we have for grain the other one that's 80 and divided by the Numbers we have for meat which is 40. reduce that fraction down and that means that the opportunity cost for producing one ton of meat for big country is two tons of grain now we're going to calculate the opportunity cost for little country when they produce one ton of grain the opportunity costs of the numbers we have for the other one 20 divided by 20. and that gives us one ton of meat lost for every ton of grain produced and the opportunity cost for the production of meat is the numbers we have for the other one still 20 divided by 20 again and that means that the opportunity cost of producing one ton of meat is one ton of grain for little country so now that we have the opportunity cost calculated here let's remember that comparative advantage is the ability to produce something at a lower opportunity cost so which country has the comparative advantage in the production of grain well big country has a opportunity cost of half a ton of meat while little country has an opportunity cost of one ton of meat which is smaller half a ton or one ton so big country does have the comparative advantage in the production of grain because half a ton of meat is a lower opportunity cost than one ton of meat so which country has the comparative advantage in the production of meat again we're going to compare the opportunity costs here big country has an opportunity cost of two tons of grain every time they produce one ton of meat well little country on the other hand has an opportunity cost of one ton of grain every time they produce a ton of meat and since one ton of grain is a lower opportunity cost than two tons of grain little country has the comparative advantage in the production of meat and if both countries specialize in the production of the good for which they have the comparative advantage their production points on their production possibilities curves would be right here for big country that's 80 tons of grain and zero tons of meat being produced now little country is going to produce 20 tons of meat and zero tons of grain now big country is not going to consume all 80 tons of grain and little country is not going to consume all 20 tons of meat now that they have specialized they're going to trade for the other product using the product they've made now the two countries are going to negotiate the terms of this trade and both countries will be seeking a terms of trade that will be beneficial to them if both countries are going to benefit from trade that means the terms of trade are mutually beneficial and those mutually beneficial terms will fall between their two opportunity costs for a particular good so when it comes to grain one ton of grain if it's mutually beneficial will be worth between half a ton of meat and one ton of meat and one ton of meat on the other hand will be worth between one and two tons of grain if the terms of trade are mutually beneficial but what if one ton of grain is actually traded for three tons of meat well big country has the comparative advantage for grain and they want a high price for their grain anything above half a ton of meat is beneficial to them three tons is way more than half a ton so big country is going to benefit with this terms of trade little country on the other hand is not producing grain they're actually producing meat and if they have to give up more than one ton of meat they are going to be losing in this exchange and it would be better for them to produce the grain themselves so with this terms of trade being outside the mutually beneficial range big country is going to benefit and little country is going to be worse off but what if one ton of grain is actually traded for a quarter ton of meat who's helped and who's hurt by that terms of trade now big country is going to want at least a half a ton of meat and since it's lower than that they are going to be hurt now little country wants to give up no more than one ton of meat and this is way less than one ton of meat and so big country is hurt and little country is helped by this terms of trade so if the terms of trade are above the mutually beneficial range for the good we're trading just one unit of that means the country with the comparative advantage and the production of that good will be better off while the country without the comparative advantage will be worse off and if the terms of trade are below the mutually beneficial range for the product we're trading just one unit of then that is going to hurt the country with the comparative advantage in the production of that good and benefit the country without the comparative advantage and that good now let's see what happens when these two countries trade let's say they negotiate and agree upon a mutually beneficial terms of trade here where one ton of meat is worth one and a half tons of grain let's say that little country trades away 10 tons of meat for 15 Tons of big countries great on our production possibilities curve that means big country is going to be losing 15 Tons of grain and gaining 10 tons of meat and that means they are consuming at that point there outside their curve little country on the other hand is going to gain 15 Tons of grain and lose 10 tons of meat that means they are at that point there for their consumption of grain and meat now remember a production possibilities curve is the maximum amount of production it is impossible to produce outside of one's production possibilities curve but as we see through specialization and trade it is possible to consume outside one's production possibilities curve and that shows us the benefit of specialization and trade using comparative advantage now let's take a look at another type of problem these are called input problems these are inputs because the numbers we have in this table minutes are units of Labor that go into the production of a particular product in this case the product is mopping and vacuuming actually takes six minutes to mop while Omar takes 12 minutes vacuuming takes Ashley three minutes and Omar takes four minutes now who has the absolute advantage in both mopping and vacuuming since this is an input problem using fewer resources to produce a good is the absolute Advantage here and that means Ashley has the absolute advantage in vacuuming because three minutes is less than four minutes and when it comes to the absolute advantage in mopping Ashley still has the absolute Advantage because six minutes of Labor is less than 12 minutes of labor now when it comes to an input problem you're never going to see it as production possibilities curves you're only going to see it as a table or perhaps a word problem but when we're calculating comparative advantage with a input problem the opportunity cost is calculated using the it over formula so with inputs the opportunity cost of producing one unit of good a is the numbers for it a divided by the numbers for B so for Ashley we're going to look at the opportunity cost of one mopping it will be the numbers we have for mopping which is six divided by the Numbers we have for vacuuming three and that means for every mopping Ashley is going to give up two vacuumines that's our opportunity cost the opportunity cost of producing one vacuuming is the numbers we have for vacuuming three divided by six which is one half of a mopping for every vacuuming she does now Omar's opportunity cost for mopping is the numbers we have for mopping 12 divided by the Numbers we have for vacuuming the other one which is four twelve divided by four means three vacuumines are lost every time Omar does a mopping and that means the opportunity cost of producing one vacuuming is the reciprocal here it's always going to be the reciprocal of the first good 4 divided by 12 which is one third of a mopping and one more time comparative advantage is the ability to produce something at a lower opportunity cost so who has the comparative advantage in mopping well that is going to be Ashley because losing two vacuumings is going to be a lower opportunity cost than losing three vacuumings so Ashley has the comparative advantage because two is less than three so who has the comparative advantage for the other product in this case vacuuming since one-third is less than one half Omar has the comparative advantage in vacuuming so if Ashley is going to specialize in the production of mopping while Omar is going to specialize in the production of vacuuming they can trade services with each other and find mutually beneficial terms of trade within their opportunity costs that means one mopping will be mutually beneficial if it's traded for two vacuumings up to three vacuumines now mutually beneficial terms of trade for vacuuming will fall between one third of a mopping up to one half of a mopping and those terms would make both Ashley and Omar better off and there you have it that is everything you need to know about comparative advantage including absolute Advantage if you're ready to practice this head over to review econ.com and play the comparative advantage game to make sure you really understand it and if you still need more help after that remember to pick up that total review booklet it has everything you need to know to Ace your microeconomics or macroeconomics AP exams that's it for now I'll see y'all next time