Subjects and resources that you bookmark will appear here.
4 min read•september 12, 2020
Jeanne Stansak
The concepts of absolute advantage and comparative advantage illustrate how individual countries or entities interact and trade with each other. For example, countries can specialize in what they are good at producing and then trade for goods and services that they are not as efficient at.
There are two types of problems within these concepts:
The rules for these problems are:
Determining Absolute Advantage
Using the table above, we would determine that Japan has absolute advantage in steel (1200 > 1000) and Canada has absolute advantage in coal (500 > 300).
Determining Comparative Advantage
The per unit opportunity cost for 1 unit of steel in Canada is 1/2 unit of coal (500/1000)
The per unit opportunity cost for 1 unit of steel in Japan is 1/4 unit of coal (300/1200)
Since 1/4 is less than 1/2, Japan has the comparative advantage in steel.
The per unit opportunity cost for 1 unit of coal in Canada is 2 units of steel (1000/500)
The per unit of opportunity cost for 1 unit of coal in Japan is 4 units of steel (1200/300)
Since 2 is less than 4, Canada has the comparative advantage in coal.
Therefore, Japan will export steel to Canada and import coal from Canada.
Terms of Trade
Terms of trade are determined by looking at the two opportunity costs and choosing a number that falls between the opportunity costs in order for it to be beneficial to both countries.
Acceptable terms of trade for this situation would be:
The rules for these problems are:
Determining Absolute Advantage
Using the table, we would determine that Brazil has an absolute advantage in the production of cars (2 hours < 3 hours). Brazil also has an absolute advantage in the production of trucks (2 hours < 6 hours).
Determining Comparative Advantage
The per unit opportunity cost for 1 car in the United States is 1/2 a truck (3 divided by 6).
The per unit opportunity cost for 1 car in Brazil is 1 truck (2 divided by 2).
Since 1/2 is less than 1, the United States has a comparative advantage in the production of cars.
The per unit opportunity cost for 1 truck in the United States is 2 cars (6 divided by 3).
The per unit opportunity cost for 1 truck in Brazil is 1 car (2 divided by 2).
Since 1 is less than 2, Brazil has comparative advantage in the production of trucks.
Therefore, the United States will export cars to Brazil and import trucks from Brazil.
Terms of Trade
Terms of trade are determined by looking at the two opportunity costs and choosing a number that falls between the opportunity costs in order for it to be beneficial to both countries.
Acceptable terms of trade for this situation would be:
Thousands of students are studying with us for the AP Microeconomics exam.
join nowBrowse Study Guides By Unit