We will introduce absolute and comparative advantage using a simple example involving two individuals. Then, we use these concepts in an analysis of countries and how, when they are allowed to trade, countries can achieve combinations of goods that are outside (i.e., to the right of) their production possibility frontiers.
First, two definitions.
An economic agent (i.e., an individual, firm, country) has an absolute advantage when it can make more of a good than another economic agent. Or it can make the same amount of a good using fewer resources.
An economic agent has a comparative advantage when it can produce a good at a lower opportunity cost than another economic agent.
Second, to give a preview, the general lesson here is going to be that countries should produce the goods for which they have a comparative advantage.
An example: painting and mowing
Kate can either paint 3 rooms or she can mow 6 laws per day. Sam meanwhile can only paint 1 room or mow 1 lawn per day.
Kate has an absolute advantage painting rooms and an absolute advantage mowing lawns. In one day, she can produce more mowed lawns and more painted rooms.
Kate, however, can’t do everything. Hence, we need to determine who has a comparative advantage painting rooms and who has a comparative advantage mowing lawns. To do this, we must figure out the cost—that is, the opportunity cost—of each person doing both jobs. Here is how we do proceed.
If Kate paints, then she gets three rooms done in one day. Painting those three rooms, however, means that six lawns don’t get mowed. Reducing this, for each room that she paints two lawns don’t get mowed (3R = 6L, and so 1R = 2L). Hence, the cost of painting a room (i.e., the opportunity cost) is two mowed lawns. On the other hand, if Kate mows lawns, then she gets six lawns mowed but doesn’t paint three rooms. Reducing this, each time she mows a lawn, half a room doesn’t get painted (6L = 3R, and so 1L = 1/2R). Therefore, the opportunity cost of mowing one lawn is half a painted room.
At the same time, if Sam paints, then he gets 1 room done and he doesn’t mow one lawn. The opportunity cost of that one room is 1 lawn. And if Sam mows lawns, then he gets 1 lawn done and he doesn’t paint one room. The opportunity cost of that 1 mowed lawn is 1 painted room.
|paint 1 room
|mow 1 lawn
Remember, an economic agent has a comparative advantage when they can produce a good at a lower opportunity cost. Opportunity costs are costs, and so, as always, we want to produce a good for the lowest possible cost (assuming that quality can be kept the same). So, who—Kate or Sam—can paint rooms for the lowest cost? And who can mow lawns for the lowest cost?
Sam can paint rooms for a lower cost than can Kate. The opportunity cost of having him paint a room is only one mowed lawn, whereas it costs us two lawns when Kate does this. At the same time, Kate can mow lawns for a lower cost. The opportunity cost of having her mow a lawn is only half a painted room; it costs us one whole painted room to have Sam mow a lawn.
So, Kate has a comparative advantage mowing lawns, and Sam has a comparative advantage painting rooms.