Absolute Advantage Absolute Advantage
Two countries: Alpha and Omega. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Both goods are produced using labor as the only input. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Both goods are produced using labor as the only input. In Alpha, 2 workers = 1 car and 10 workers = 1 computer. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Both goods are produced using labor as the only input. In Alpha, 2 workers = 1 car and 10 workers = 1 computer. In Omega, 4 workers = 1 car and 100 workers = 1 computer. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Both goods are produced using labor as the only input. In Alpha, 2 workers = 1 car and 10 workers = 1 computer. In Omega, 4 workers = 1 car and 100 workers = 1 computer. Alpha produces both goods more efficiently (i.e., using fewer resources) than Omega. Absolute Advantage
Two countries: Alpha and Omega. Two goods: computers and cars. Both goods are produced using labor as the only input. In Alpha, 2 workers = 1 car and 10 workers = 1 computer. In Omega, 4 workers = 1 car and 100 workers = 1 computer. Alpha produces both goods more efficiently (i.e., using fewer resources) than Omega. Alpha has an absolute advantage in the production of both goods relative to Omega. Comparative Advantage in Producing Computers Comparative Advantage in Producing Computers
Alpha must give up 5 cars to produce 1 computer: its opportunity cost of producing 1 computer is 5 cars. Comparative Advantage in Producing Computers
Alpha must give up 5 cars to produce 1 computer: its opportunity cost of producing 1 computer is 5 cars. Omega must give up 25 cars to produce 1 computer: its opportunity cost of producing 1 computer is 25 cars. Comparative Advantage in Producing Computers
Alpha must give up 5 cars to produce 1 computer: its opportunity cost of producing 1 computer is 5 cars. Omega must give up 25 cars to produce 1 computer: its opportunity cost of producing 1 computer is 25 cars. Because Alpha’s opportunity cost of producing computers is smaller than Omega’s, Alpha has a comparative advantage in producing computers (relative to Omega). Comparative Advantage in Producing Cars Comparative Advantage in Producing Cars
Alpha must give up 0.2 computers to produce 1 car: its opportunity cost of producing 1 car is 0.2 computers. Comparative Advantage in Producing Cars
Alpha must give up 0.2 computers to produce 1 car: its opportunity cost of producing 1 car is 0.2 computers. Omega must give up 0.04 computers to produce 1 car: its opportunity cost of producing 1 car is 0.04 cars. Comparative Advantage in Producing Cars
Alpha must give up 0.2 computers to produce 1 car: its opportunity cost of producing 1 car is 0.2 computers. Omega must give up 0.04 computers to produce 1 car: its opportunity cost of producing 1 car is 0.04 cars. Because Omega’s opportunity cost of producing cars is smaller than Alpha’s, Omega has a comparative advantage in producing cars (relative to Alpha). Comparative Advantage in Producing Cars
Alpha must give up 0.2 computers to produce 1 car: its opportunity cost of producing 1 car is 0.2 computers. Omega must give up 0.04 computers to produce 1 car: its opportunity cost of producing 1 car is 0.04 cars. Because Omega’s opportunity cost of producing cars is smaller than Alpha’s, Omega has a comparative advantage in producing cars (relative to Alpha). Even if a country has an absolute disadvantage in all goods, it will nonetheless have a comparative advantage in some good. World Output with and without Specialization World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage. World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, and Omega puts all its workers in cars: World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, and Omega puts all its workers in cars: Output of cars Output of computers World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, and Omega puts all its workers in cars: Output of cars Output of computers Alpha 150 70 World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, and Omega puts all its workers in cars: Output of cars Output of computers Alpha 150 70 Omega 250 0 World Output with and without Specialization
Let each country have 1000 workers, and suppose that each country allocates half its workers to each of the goods: Output of cars Output of computers Alpha 250 50 Omega 125 5 Total 375 55 Suppose now that each country specializes in its comparative advantage.Forexample,Alpha puts 300 workers in cars and 700 workers in computers, and Omega puts all its workers in cars: Output of cars Output of computers Alpha 150 70 Omega 250 0 Total 400 70 Trade Trade
Now allow Alpha and Omega to trade with each other. Trade
Now allow Alpha and Omega to trade with each other. Suppose the terms of trade are set at 12 cars for 1 computer. Trade
Now allow Alpha and Omega to trade with each other. Suppose the terms of trade are set at 12 cars for 1 computer. Alpha is happy to give up 1 computer in exchange for 12 cars because its opportunity cost of producing 1 computer is only 5 cars (i.e., in the absence of trade, it gets only 5 extra cars when it produces 1 less computer). Trade
Now allow Alpha and Omega to trade with each other. Suppose the terms of trade are set at 12 cars for 1 computer. Alpha is happy to give up 1 computer in exchange for 12 cars because its opportunity cost of producing 1 computer is only 5 cars (i.e., in the absence of trade, it gets only 5 extra cars when it produces 1 less computer). Omega is happy to give up 12 cars in exchange for 1 computer because its opportunity cost of producing 1 computer is 25 cars (i.e., in the absence of trade, it must give up 25 cars in order to produce 1 more computer). Trade
Now allow Alpha and Omega to trade with each other. Suppose the terms of trade are set at 12 cars for 1 computer. Alpha is happy to give up 1 computer in exchange for 12 cars because its opportunity cost of producing 1 computer is only 5 cars (i.e., in the absence of trade, it gets only 5 extra cars when it produces 1 less computer). Omega is happy to give up 12 cars in exchange for 1 computer because its opportunity cost of producing 1 computer is 25 cars (i.e., in the absence of trade, it must give up 25 cars in order to produce 1 more computer). Suppose, then, that Alpha gives Omega 10 computers in exchange for 120 cars. Trade
Now allow Alpha and Omega to trade with each other. Suppose the terms of trade are set at 12 cars for 1 computer. Alpha is happy to give up 1 computer in exchange for 12 cars because its opportunity cost of producing 1 computer is only 5 cars (i.e., in the absence of trade, it gets only 5 extra cars when it produces 1 less computer). Omega is happy to give up 12 cars in exchange for 1 computer because its opportunity cost of producing 1 computer is 25 cars (i.e., in the absence of trade, it must give up 25 cars in order to produce 1 more computer). Suppose, then, that Alpha gives Omega 10 computers in exchange for 120 cars. What is the resulting allocation of goods across the two countries? The Allocation of Goods after Trade The Allocation of Goods after Trade
After trade, Alpha and Omega consume cars and computers as follows: The Allocation of Goods after Trade
After trade, Alpha and Omega consume cars and computers as follows:
Consumption of cars Consumption of computers The Allocation of Goods after Trade
After trade, Alpha and Omega consume cars and computers as follows:
Consumption of cars Consumption of computers Alpha 150 + 120 > 250 70 − 10 > 50 The Allocation of Goods after Trade
After trade, Alpha and Omega consume cars and computers as follows:
Consumption of cars Consumption of computers Alpha 150 + 120 > 250 70 − 10 > 50 Omega 250 − 120 > 125 0 + 10 > 5 The Allocation of Goods after Trade
After trade, Alpha and Omega consume cars and computers as follows:
Consumption of cars Consumption of computers Alpha 150 + 120 > 250 70 − 10 > 50 Omega 250 − 120 > 125 0 + 10 > 5
After specializing in production and then trading at favorable terms of trade, each country consumes more of both goods than it would have under “autarky” (i.e., no trade)!