Comparative Advantage Simplified - IB/AP/College

Overview

• Comparative Advantage is crucial for efficient resource use in economics.
• Frequently appears in both microeconomics and macroeconomics AP exams.

Key Concepts

Absolute Advantage

• Definition: Ability to produce more with the same resources or the same amount with fewer resources than another entity.
• Example: Davis types more pages per hour than Katrina, so he has an absolute advantage in typing.

Comparative Advantage

• Definition: Ability to produce a good at a lower opportunity cost than another entity.
• Opportunity Cost: Measured differently for outputs vs. inputs.

Calculating Opportunity Cost

1. Outputs (Fixed Inputs)

   • Use the "Other Over" formula: Opportunity Cost of 1 A = B/A of B.
   • Example: William and David's pie and cake production.
     • William has a comparative advantage in pies (lower opportunity cost).
     • David has a comparative advantage in cakes.

2. Inputs (Fixed Outputs)

   • Use the "It Over" formula: Opportunity Cost of 1 A = A/B of B.
   • Example: Time taken to produce pies and cakes.
     • Similar comparative advantages as in output-based calculations.

Terms of Trade

• Definition: Rate at which goods are exchanged favorably between entities.
• Mutually Beneficial Terms:
  • Should fall between the entities' opportunity costs.
  • Example: 1 pie traded for between 1/2 and 2/3 of a cake.

Practical Application

• Specialization according to comparative advantage can allow entities to consume beyond their production possibilities.
• Example: David and William trading pies and cakes.

Exam Connections

• Appears in AP Microeconomics multiple choice questions.
• Relevant Practice: Released AP Microeconomics Exam Questions (2012): Q16, Q31.

Resources

• Recommended: Marginal Revolution University Video
• Practice: Comparative Advantage Review Game

Acknowledgements

• Inspirations from Reffonomics.com and various educators.