Absolute vs. Comparative

DefinitionsAbsolute Advantage= the product or

resource that a person, group, or society can produce more of (absolutely).

Comparative Advantage= the product or resource that a person, group, or society can produce at the least possible cost.

Why Comparative Advantage? David Ricardo Says…Specialization.

Economies or Indiviuals are better off finding their comparative advantage and specializing in that good, and then trading with other countries or people specialized goods.

Calculating the Comparative Advantage:

United States Vietnam

Shrimp 1000 2000

Computers 2000 1000

Step 1: Find the cost of producing just 1 unit of each good

Calculating the Comparative Advantage:

United States Vietnam

Shrimp 1000 2000

Computers 2000 1000

US Vietnam1 shrimp= 2 comp 1 shrimp= ½ comp1 comp.= ½ shrimp 1 comp.= 2 shrimp

Calculating the Comparative Advantage:The US has the Comparative Adv. in ____Vietnam has the Comparative Adv. in ___What does this mean?

The U.S. will specialize in making computers and trade with Vietnam for shrimp and vice versa. In the long run both countries will be better off for specializing. United States Vietnam

Shrimp 1000 2000

Computers 2000 1000

US Vietnam1 shrimp= 2 comp 1 shrimp= ½ comp1 comp.= ½ shrimp 1 comp.= 2 shrimp

What’s a good trade?Terms of Trade: Trade that will be mutually

advantageous for both countries. Look back at the cost involved in

producing shrimp and computers for each country.

US Vietnam1 shrimp= 2 comp 1 shrimp= ½

comp1 comp.= ½ shrimp 1 comp.= 2

shrimp

Terms of TradeUS Vietnam

1 shrimp= 2 comp 1 shrimp= ½ comp

1 comp.= ½ shrimp 1 comp.= 2 shrimp

What would be a trade that would help both countries exceed their Production Possibilities Frontier?

½ comp.<1 shrimp<2 comp.½ shrimp < 1 comp.< 2 shrimp

Terms of Trade½ comp.<1 shrimp<2 comp.½ shrimp < 1 comp.< 2 shrimp

Would 750 shrimp from Vietnam for 1250 computers from the U.S. be an acceptable trade for both groups?

Well…

Terms of Trade1 shrimp = 1 2/3 computers1 computer = 6/10 shrimp

Does it work?½ comp.<1 shrimp<2 comp.½ shrimp < 1 comp.< 2 shrimp

YES!!