The Principle of Comparative Advantage
Comparative advantage is the ability of a person (or state, region, country) to
perform an activity or produce a good or service at a lower
opportunity cost than someone else (or some other
state, region, or country).
Liz’s Smoothie Bar
Lizzie can make smoothies or salads. Her production possibilities are as follows:
Measuring Liz’s Opportunity Cost
It takes me 90 seconds to do one salad—90 seconds that could have been used to
make one smoothie.
Thus:
1 smoothie = 1 salad
and
1 salad = 1 smoothie
Joe’s Smoothie Bar
Joe can make smoothies or salads. His production possibilities are as follows:
Measuring Joe’s Opportunity Cost
Thus:
1 salad = 1/5 smoothie
and
1 smoothie = 5 salads
It takes me 10 minutes make one smoothie—I could make 5 salads in
10 minutes.
Absolute Advantage
Notice that Liz has an absolute advantage over Joe—that is, she can make more salads and smoothies per hour.
Does it follow there would be no advantages to specialization and trade?
Liz has the comparative advantage in smoothies, since she can make them at lower
opportunity cost than Joe. Joe has the comparative advantage
in salads—since he must sacrifice 1/5 smoothie per salad;
whereas Liz must sacrifice 1 smoothie per salad.
Terms of Trade
I am willing to trade if I can get more than one salad in
exchange for one smoothie.
I am willing to trade if I can get more than one fifth of a
smoothie in exchange for one salad (or pay less than 5 salads
1 smoothie)
These terms are advantageous to both Liz and Joe!!
1 smoothie buys 2 salads
Or:
2 salads buys one smoothie
Gains from Specialization
Complete Practice problem 3.5 on p. 84
Snowboards
Skis0
Tony’s PPFPatty’s PPF
50
20
10
25
a. Calculate Tony’s opportunity cost of a snowboard.
b. Calculate patty’s opportunity cost of a snowboard.
c. Who has the comparative advantage in producing snowboards?
d. Who has the comparative advantage in producing skis?
e. If the specialize and trade, how many snowboards and skis will they produce?