MODULE 4: COMPARATIVE ADVANTAGE AND TRADE

In the previous module, students have learned that the simple model of production possibilities is used to
demonstrate scarcity, trade-offs, opportunity costs and economic growth. One of the results of the model
is that a nation cannot consume beyond the production possibilities curve. However, if two or more
nations trade based upon comparative advantage, we can demonstrate that nations can consume beyond
their own PPC. These mutually beneficial trades lead to more prosperity for individuals and for nations.

Student learning objectives:

In the previous module, students were taught that a nation cannot consume beyond the PPC until
economic growth expands the PPC over time.
• How trade leads to gains for an individual and for national economies.
• The important distinction between absolute advantage and comparative advantage.
• How comparative advantage leads to gains from trade in the global marketplace.

Key Economic Concept For This Module:

• The key concept in this module is that anytime two nations (or individuals) have
differing opportunity costs of production, there is an opportunity to gain from trade.

Common Student Difficulties:

• The difference between absolute and comparative advantage, and why it is comparative
advantage that creates opportunities for trade, must be stressed
• Students can sometimes get confused in determining which nation should export which
product. A slow, methodical, approach to presenting a good example can significantly help.
• When students are able to determine comparative advantage, they can get confused in
selecting terms of trade that are mutually beneficial.
Module 4: Comparative Advantage and Trade 21
In-Class Presentation of Module and Sample Lecture
Suggested Time: This module should be covered in two hour-long classes. Multiple examples will pay
off.

I. There Are Gains From Trade

II. Comparative Advantage and Gains From Trade

The basic principle of comparative advantage rests on differing opportunity costs of producing various
goods and services.
Trading partners can both benefit if they specialize and trade based upon comparative advantage.

I. There Are Gains From Trade

Ask the students: Who made their shoes? What have they eaten today? Who grew the food they ate?
Why didn’t the students perform these tasks themselves?
Are we better off because we can focus on being a student while someone else focuses on growing food
or manufacturing our clothes?

A Trip to the Dentist

Everyone has been to the dentist and we have all had an experience similar to this:
You arrive, and are greeted by a receptionist. A hygienist takes x-rays of your mouth, then cleans and
polishes your teeth. In the last five minutes of your visit, the actual dentist shows up. He/she inspects the
work of the hygienist and asks if the hygienist has found anything out of the ordinary in your mouth.

Why doesn’t the dentist perform all of these tasks? Isn’t he/she qualified to greet you at the door, take the
x-rays, clean and polish your teeth and determine if there are any problems?
What is the dentist doing while you spend your time with the hygienist?
He or she is doing extractions, cosmetic surgery, root canals, etc; the stuff that actually requires a medical
degree to perform.

So if your dentist performed all of the tasks that go into a typical visit to the dentist’s office, much of the
specialized work would go undone. By employing a receptionist and a hygienist, all three persons can
specialize and much more production is done.

II. Comparative Advantage and Gains From Trade

The students will have followed the example of Tom and Hank in the text, so class time could be spent
using an example of two U.S. states.
Note: Depending on your region of the country, you could select states (or even cities) that have a natural
rivalry that could spice up the discussion and keep students engaged.

Two states, Oregon and Washington

Before trade, both states are self-sufficient in apples and timber and can produce at the levels shown
below.
State Apples Timber Opp. Cost of 1 Timber = Opp. Cost of 1 Apple =
Oregon 10 40 .25 Apple 4 Timber
Washington 40 10 4 Apple .25 Timber

Note the absolute advantage that Oregon has in timber and Washington has in apple production.

Draw these PPF’s. Assume each is producing (and consuming) at the midpoint.
22 Section 1: Basic Economic Concepts
So Oregon has 20 timber, 5 apples. Washington has 20 apples, 5 timber.

Total timber production: 25

Total apple production: 25

How can these states increase output?

The principle of comparative advantage says that total output will be greatest when each good is produced
by the state that has the lower opportunity cost.

Washington has comparative advantage in apple production and should specialize in apples.
Oregon should specialize in timber because of their comparative advantage.
Note that if they specialize, they’ll produce (together) more apples and timber than they had individually
without specialization.

In the PPC’s for each state, show the points of specialization.

Total timber production: 40 (all in Oregon)

Total apple production: 40 (all in Washington)

So now Oregon doesn’t have anything to eat, and Washington doesn’t have any shelter. Maybe a trade is
in order?

Oregon will export Timber, Washington will export Apples.

Since each nation would like some of both goods, they will now have to trade.
The original cost conditions in each country will limit the terms of trade.
In Washington 1 apple = .25 timber, so Washington must get more than .25 Timber for each 1 unit of
apples exported, or they will not benefit from export.
In Oregon 1 apple costs 4 timber, so Oregon will not give up more than 4 timber to get 1 apple.
The rate of exchange will be somewhere between .25 and 4 timbers for each apple.
Suppose they negotiate a trade where Washington sends 20 apples to Oregon in exchange for 20 timber.

Module 4: Comparative Advantage and Trade 23

Consumption after trade:

Oregon: 20 Timber and 20 Apples

Washington: 20 Timber and 20 Apples

Show these points outside of both PPC’s.

Stress to the students that without trade, each state is constrained by the PPC. But with trade, they are
well beyond the PPC.

These chalkboard gains from trade really demonstrate why virtually all economists advocate free and
fair trade.
24 Section 1: Basic Economic Concepts
In-Class Activities and Demonstrations
If the students have followed the example from the text, and you have presented an additional example
similar to the one presented above, you might use extra time in the second hour to discuss other
situations where comparative, not absolute advantage might come into play. You might also use the
worksheet below as an in-class activity that will allow for some practice before an exam.

Student Project Example In groups of three, students are assigned a library research project,
write a paper and prepare a presentation of the results.
Suppose Tammy is the best researcher, the best writer, and the best public speaker. In other
words, Tammy has absolute advantage in all tasks. Should Jim and Anna let Tammy do all the
work while they do nothing? If they did that, the project would not be completed in time and all
would suffer a poor grade. But if they divided up the tasks based upon comparative advantage, or
who could perform a task at the lowest opportunity cost, and specialized, the project might be a
smashing success.

An Input Example The AP exam tests comparative advantage in two ways: as an output
problem (the Oregon/Washington example) or as an input problem. The input problem is
sometimes confusing for the students, so the instructor should present an example so that they are
familiar with it on exam day.

Note: when giving the students the table below, leave the last two columns empty.
Students are presented with a problem that describes two towns and how many hours (the input) that
it takes to produce each product. Suppose:

Hours to produce Hours to produce Producing 1 unit Producing 1 unit

1 unit of Donuts 1 unit of Coffee Of donuts costs of coffee costs
Springfield 8 4 2 unit of coffee ½ unit of donuts
Shelbyville 24 8 3 units of coffee 1/3 unit of donuts

Springfield has an absolute advantage producing both donuts and coffee because it takes them fewer
hours. Why would Springfield want to trade if they can do more of both?

Have students put in terms of opportunity cost to find the comparative advantage. Here is where the last
two columns of the table are completed.

Every unit of donuts Springfield produces requires them to give up 8 hours in which they could
have made 2 units of coffee.
Thus in Springfield, 1 donut = 2 coffee.
In Shelbyville, each unit of donuts requires them to give up 24 hours in which they could have produced
3 units of coffee.
So, in Shelbyville, 1 donut = 3 coffee.
Springfield therefore has a comparative advantage producing donuts.
Shelbyville has a comparative advantage in producing coffee, because to produce one coffee they give up
1/3 of a unit of donuts, while Springfield must give up ½ a unit of donuts.
Module 4: Comparative Advantage and Trade 25
Comparative Advantage and Trade Exercise: Distribute this worksheet to the students, perhaps
in groups of 2 or 3. You might consider allocating about 20-30 minutes for completion and discussion
of the exercise.

The U.S. and England have the following production possibility curves.

Using the information on the graphs above:

The opportunity cost of 1 unit of Fish in the U.S. is ________________________.

The opportunity cost of 1 unit of Chips in the U.S. is _________________________.

The opportunity cost of 1 unit of Fish in England is _________________________.

The opportunity cost of 1 unit of Chips in England is ________________________.

The U.S. has an absolute advantage in _____________________.

England has an absolute advantage in _____________________. The

U.S. has a comparative advantage in _____________________.

England has a comparative advantage in ___________________.

26 Section 1: Basic Economic
Concepts
Fill in the table below.

Without Trade With Trade With Trade

(production) (consumption)

Chips Fish Chips Fish Chips Fish

England

The U.S.

Total

Note: Assume that with trade, each country exports ½ of its production.

What happens to total world output when the countries specialize and trade? What is this called?

Are the countries better off? Explain.

Module 4: Comparative Advantage and Trade 27