Lecture Notes: Comparative Advantage vs Absolute Advantage

Key Concepts

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

  • Example: Patty's opportunity cost for producing one plate is 1/3 of a cup (lower than Charlie's).
  • Charlie's opportunity cost for producing a cup is 1/3 of a plate (lower than Patty's).

• Absolute Advantage: The ability to produce more of a good with the same amount of inputs than another producer.

  • Example: If Patty can produce more plates than Charlie with the same inputs, she has an absolute advantage in plates.

Understanding through Example

Initial Scenario

• Patty has a comparative advantage in plates due to lower opportunity cost (1/3 cup vs 3 cups for Charlie).
• Charlie has a comparative advantage in cups for a similar reason.

Absolute Advantage

• Absolute advantage cannot be determined without knowing the inputs used.
• Assuming same inputs, if Patty produces more plates than Charlie, she has an absolute advantage.
• If Charlie produces more cups than Patty using the same inputs, he has an absolute advantage.

Changes in Productivity

• Scenario: Charlie improves productivity dramatically.
  • Charlie’s PPF (Production Possibility Frontier) Improvement:
    • Can produce 40 cups or 40 plates with same inputs where Patty can produce 10 cups or 30 plates.
    • Charlie has an absolute advantage in both products now.

New Comparative Advantage Analysis

• Opportunity Costs:

  • Charlie: 1 plate = 1 cup, 1 cup = 1 plate.
  • Patty: Opportunity cost for a plate remains 1/3 of a cup.

• Despite absolute advantage, comparative advantage remains:

  • Patty still has a comparative advantage in plates.
  • Charlie maintains comparative advantage in cups.

Specialization and Trade

• Specialization Strategy:
  • Charlie should specialize in cups.
  • Patty should specialize in plates.

Trade Scenario

• Trading for Mutual Benefit:

  • Patty willing to trade 2 plates for 1 cup.
  • Charlie accepts as he would give up only 0.5 cups per plate in trade.

• Trade Outcome Example:

  • Charlie trades 10 cups for 20 plates.
  • Both parties achieve production levels beyond their individual PPFs, demonstrating gains from trade.

Conclusion

• Specialization and trade can benefit both parties, even if one has an absolute advantage in both goods, by focusing on comparative advantages.
• The example shows how both can reach outcomes unattainable individually by trading based on comparative advantages.