Week 2

Comparative Advantage - the Basis for Trade

Opportunity Cost and Specialisation
The Principal of Comparative Advantage
The Sources of Comparative Advantage
The Production Possibility Curve/Frontier
Shifts of the P.P.C.
Barriers to Specialisation

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Learning objectives
Define and determine absolute advantage
and comparative advantage
Explain how specialisation and exchange
give rise to gains from trade
Identify sources of comparative advantage
Define, construct and describe a
production possibility curve (PPC)
Explain the principle of increasing
opportunity costs
Describe the factors shifting a PPC over
time
Identify the costs and benefits of
specialisation

Diane Enahoro Session 2 2013

Lecture Outline

People living in a group (two or more) can either do

everything for themselves (be self sufficient)

or they can specialise.

If a comparative advantage exists, specialisation will
lead to higher a output for the group than self
sufficiency will.
A Production Possibilities model will show this.
Specialisation has Costs and Benefits

Diane Enahoro Session 2 2013

Comparative Advantage, Absolute Advantage

and the Production Possibility Curve(Frontier)
Absolute advantage exists where one economic agent
can produce more goods in a given time than another
economic agent can produce;
or takes less time to perform a given task.
Comparative advantage, measured in terms of
opportunity cost, exists where one economic agents
opportunity cost is lower than another economic agents
opportunity cost.
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The Principle of Comparative Advantage illustrated.

Diane is more efficient at cooking meals and at
washing dishes. She has an absolute advantage in
producing both goods
Should she cook the meals and wash dishes?
Table 1 Time taken to perform each task

Diane
Liz

Time to Cook
Meals

Time to Wash
Dishes

20 mins

10 mins

30 mins

30 mins

Diane Enahoro Session 2 2013

Table 2 same as Table 1 but showing the number of

meals each can produce in a given time (1 hour)

No of
washes in
one hour

No of meals
cooked in one
hour

By
Diane

6 washes

3 meal

By Liz

2 wash

2 meal

Diane Enahoro Session 2 2013

The Principle of Comparative Advantage states

that
Diane should produce that good in which she has a
Comparative Advantage i.e. the good where she has the
lowest opportunity cost. See lecture 1.
Reminder: Opportunity Cost is the value of the next-best
alternative to taking a particular action

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To calculate the opportunity cost ask:

1.

How many washes could Diane perform in the

time it takes her to cook a meal?

2.

How many meals could Diane have cooked in the

time it takes to wash the dishes?

3. Then ask the same questions for Liz.

Opp. Cost
of 1 Meal
For
Diane
For
Liz

Opp. Cost of
1 Wash

2 washes

meal

1 wash

1 meal

Diane Enahoro Session 2 2013

To calculate comparative advantage

1. Compare the opportunity costs for Meals for Diane
and Liz
2. Compare the opportunity cost of Washes for Diane
and Liz.
3. Then ask:
Whose opportunity cost is the lowest for
washing?

Whose opportunity cost is lowest for meals?

Diane Enahoro Session 2 2013

Answer: To calculate comparative advantage

1. Compare the opportunity costs for Meals for Diane (2) and
Liz (1)
2. Compare the opportunity cost of Washes for Diane (1/2)
and Liz (1).

Whose opportunity cost is the lowest for washing?

Whose opportunity cost is lowest for meals?

Diane Enahoro Session 2 2013

Diane

Liz

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Sources of Comparative Advantage

1. For an
a.
b.
c.

Individual
Inborn talent
Education & training
Experience

2. For a Country
a. Natural resources
b. Infrastructure
c. Cultural institutions
Comparative advantage can change over time.
Read background briefing 2.2 page 39.

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Where comparative advantage exists a country can produce

more of everything if its population engages in
specialisation.
To illustrate this using the Production Possibilities Curve
State the assumptions
Assumptions:
1. Only two workers working full time (full employment)
2. Only two goods
3. Technology is fixed

The model can be presented in:

1.In words
2.Diagrams
3.Equations

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Assumptions:
1.Two workers working 6 hours a day.

Sam (short), can produce 2kgs nuts /hour or

4kgs coffee/hour

Tim (tall) working can produce 4kgs nuts/hour or

2kgs of coffee/hour

2. Two goods-coffee grown on low bushes and nuts grown on

tall trees.
3. Technology is fixed

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Sams Production Frontier

Coffee
kg/day

Tims Production Frontier

Coffee
kg/day

24
16

12
8

4
4

12

Nuts kg / Day

16

24

Nuts kg / Day

Production Frontier = Production Possibilities Curve

shows all possible combinations of coffee and nuts
when using Sams and Tims labour fully.

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Sams Production Frontier

Coffee
kg/day

Tims Production Frontier

Coffee
kg/day

24
16

12
8

8
4

12

Nuts kg / Day

Sams Op C. nuts = loss in coffee

16

24 Nuts kg / Day

Tims Op C. nuts = loss in coffee

gain in nuts

gain in nuts

Sams Op C. coffee = loss in nuts

Tims Op C. coffee = loss in nuts

gain in coffee

Diane Enahoro Session 2 2013

gain in coffee

15

Sams Production Frontier

Coffee
24
kg/day

Tims Production Frontier

Coffee
kg/day

16

12
8

4
4

8 12

Nuts kg / Day

16

24

Sams Op C. nuts =

Tims Op C. nuts =

Sams Op C. coffee =

Tims Op C. coffee =

Diane Enahoro Session 2 2013

Nuts kg / Day

16

Combining Production Possibilities

24
Coffee
kg / Day
12

12

24

Nuts kg / Day

Who has the absolute advantage in coffee?

Who has the absolute advantage in nuts?
Who has the comparative advantage in coffee?
Who has the comparative in nuts?

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Sam does 4kg coffee/hour and 2kg nuts

Tim does 2kg coffee/hour and 4kg nuts
Let them produce 8 k of coffee and 8 k nuts each

24
Coffee kg / Day

Sam
Coffee

Nuts

Sam

Tim

Total

16

16

12

Tim
8 12

24 Nuts kg/ Day

Coffee

Nuts

Sam

-2

+1

Tim

+1

-2

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The Gains arising from Specialisation in a two

Person Economy
Result of specialisation

Coffee kg / Day

24

12

Coffee

Nuts

Sam

24

Tim

24

Total

24

24

8 12
Nuts kg / Day

24

Result of specialisation and trade

Coffee

Nuts

Sam

-1

+1

Tim

+1

-1

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The Production Possibilities Curve for a Large

Economy (many person economy)
Coffee 1000s kg/day

36
Principle of Increasing
Opportunity Costs

0
Nuts1000s kg /day
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20

The Production Possibilities Curve for a Large

Economy (many person economy)
36

Coffee 1000s kg /day

Efficient and inefficient points

Attainable and unattainable points

Productive and allocative efficient
points

36

Diane Enahoro Session 2 2013

Nuts 1000s kg /day

21

Growth and Production Possibilities

Coffee 1000s kg/day

36

36

Diane Enahoro Session 2 2013

Nuts 1000s kg /day

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Factors that Shift the PPF Outwards (Cause growth)

Economic growth is caused by:
1. Increasing productive resources

Investment in new factories and equipment

Population growth
2. Improvements in knowledge and technology

Investment in education, R&D and ICT

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Some Countries have been slow to specialise

Because of:
1.Population density and geographical isolation
2.Laws and customs that limit the freedom to
exchange goods and services

Can we have too much specialisation?

Is more specialisation always better than less?
The extent to which we should specialise depends on
costs and benefits of specialisation
What are the costs of specialisation?

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