Absolute and Comparative Advantage

Absolute Advantage

• Absolute advantage is when someone is the best at doing something– America is the best at producing entertainment– Colt Brennann (Hawaii) is the best at throwing

touchdown passes– Lance Armstrong is the best cyclist

• Are there cases where someone might be the best at something but it’s better for them to not do it?

Comparative Advantage

• Yes! If Lance Armstrong is the best cyclist and the best typist, while Susie Smith is a weak cyclist and a moderate typist, who should do which task?– Comparative advantage is when a person can

produce something at a lower cost than anyone else– In this scenario, Susie has the comparative

advantage because it cost her less (in giving up a weak cycling skill) to perform the typing.

Comparative Advantage

• In order to find people’s comparative advantage you DO NOT compare their absolute advantage.– Instead compare their opportunity costs– Why? Because we all know that superhuman that

is way better than us at everything—but can they do it all? Nope.• Therefore, we have to look at who has the lower

opportunity cost to determine who should do what task (make which good).

Comparative Advantage

• America has an absolute advantage in technology production and answering service calls when compared to India– So why does India answer the phones (even with hard to

understand accents for the caller)?• Simple, America has to give up too many technology

producers (a very complex field) to answer phones– It is better to give away the inferior task, even if it’s not

going to be done to the superior nature it could have been if it results in a higher quantity of the first option (technology) being produced

Before learning SpecializationLook at the chart below—notice how much each area is able to

produce

Before Specialization

Hours Worked Production and Consumption

Alaska 4 (making salmon)

5 pounds of salmon

4 (making coffee)

1 pound of coffee

Brazil 4 (making salmon)

1 pound of salmon

4 (making coffee)

5 pounds of coffee

• If Alaska works 8 hours with NO TRADE they have 5lbs salmon and 1lb of coffee

• If Brazil works for 8 hours with NO TRADE they have 1lb of salmon and 5lbs of coffee

After Learning Specialization After Specialization

Hours Worked

Production

Alaska 8 (making salmon)

10 pounds of salmon

Brazil 8 (making coffee)

10 pounds of coffee

• If they specialize and make what they make best Alaska spends all it’s time making salmon while Brazil only makes coffee

• Okay, so now what? The Alaskan has 10 pounds of salmon, but no coffee. How can the Alaskan make this work to his benefit?

• TRADE! If he gives the Brazilian half his salmon, he will still have 5 pounds of salmon and now he’ll have 5 pounds of coffee too!

• Before specialization the Alaskan only had 1 pound of coffee—so in in the end, he comes out with an extra 4 pounds of coffee and didn’t have to do any additional work!

• This is why America, despite being awesome at most things chooses to have other countries produce some (okay, many) of our goods. This allows us to specialize in what is going to make us the most money (bring most utility)

Sample ProblemsCars Computers

United States 12 4

Japan 10 6

• Who has absolute advantage in cars?– United States

• Who has absolute advantage in computers?– Japan

Sample ProblemsCars Computers

United States 12 4

Japan 10 6

• Who has comparative advantage in computers?

• Japan has comparative advantage in computers because they only have to give up 5/3rds of a car versus the U.S. who has to give up 3 cars to make 1 computer

• HINT: always put the item asked about in the denominator

United States’ opportunity cost of computers: 12 3----- = ----- = 3 cars 4 1

Japan’s opportunity cost of computers:

10 5---- = ----- = 5/3rds of a car6 3

Sample ProblemsCars Computers

United States 12 4

Japan 10 6

• Who has comparative advantage in cars?

• United States has the comparative advantage because they only have to give up 1/3rd of a computer versus 3/5ths that Japan has to give up

United States’ opportunity cost of computers: 4 1----- = ----- = 1/3rd of a computer 12 3

Japan’s opportunity cost of computers:

6 3---- = ----- = 3/5th of a computer10 5

Video ClipEconomics in 60 Seconds

• http://www.youtube.com/watch?v=38hvvAzgXZY

You TryBananas Rice

Fiji 10 5

China 10 2

• Who has absolute advantage in bananas?

• Who has absolute advantage in rice?

• Who has comparative advantage in rice?

• Who has comparative advantage in bananas?

You TryBananas Rice

Fiji 10 5

China 10 2

• Who has absolute advantage in bananas?– Neither-both produce 10

bananas

• Who has absolute advantage in rice?– Fiji has absolute

advantage

You TryBananas Rice

Fiji 10 5

China 10 2

• Who has comparative advantage in bananas? Explain.

• China• China only gives up 1/5

rice whereas Fiji has to give up 1/2 rice

Fiji’s opportunity cost of bananas: 5 1----- = ----- = 1/2 rice 10 2

China’s opportunity cost of bananas:

2 1---- = ----- = 1/5 rice10 5

You TryBananas Rice

Fiji 10 5

China 10 2

• Who has comparative advantage in rice? Explain.

• Fiji• Fiji only has to give up 2

bananas whereas China has to give up 5 bananas

Fiji’s opportunity cost of rice: 10 2----- = ----- = 2 bananas5 1

China’s opportunity cost of rice:

10 5---- = ----- = 5 bananas2 1

Sample Problems• A look at the worksheet (Lesson 1, Activity 2)

Mike DebbieVacuuming 60 min. 45 min.Wash dishes 30 min. 45 min.

What is Mike’s opp. cost of vacuuming in terms of washing dishes? (In other words, how many loads of dishes does he have to give up to vacuum the room)

Answer—2 loads of dishes (60 min./30 min.) = 2Let’s try another one

Sample ProblemsMike Debbie

Vacuuming 60 min. 45 min.Wash dishes 30 min. 45 min.

What is Mike’s opp. cost of doing dishes in terms of vacuuming? (In other words, how much vacuuming does he have to give up to do dishes)

Answer—1/2 of a room vacuumed (30 min./60 min.) = .5

What about Debbie? She has to give up 1 room vacuumed for 1 load of dishes (45/45=1)

Sample Problems

• So if Debbie has to give up 1 room vacuumed to do a load of dishes meanwhile Mike has to give up ½ a room to do a load of dishes; who has the comparative advantage of doing dishes?

• Mike does because it only costs him ½ a room to Debbie’s 1 room.