Comparative and Absolute Advantage

The aim of this resource is to allow you to see how comparative and absolute advantage are calculated by playing around with different numbers.

The Data

Suppose you have two countries: Country 1 and Country 2. Each country can produce two products, Good A and Good B.

You can change the names of the countries and products by clicking here:

One worker in each country can produce as follows:

These values are generated at random. You can change them on the table above, or generate new random values by pressing here:

The Production Possibility Frontier (PPF) for each of these countries is shown above. We draw straight lines because we assume perfect factor substitutability.

The information above will allow us to determine which country has comparative and absolute advantage for the production of each good.

Comparative vs Absolute Advantage

Absolute Advantage describes a situation in which a country can produce a product at a lower unit cost. In other words, the nation can produce more of that product with its scarce resources.

We can find which country has absolute advantage by in each good by:

Looking at the table to see which country can produce more of the good (per worker) or
Seeing which country has a higher axis intercept for the good on the PPF

Comparative Advantage describes a situation in which a country can produce a product at a lower opportunity cost than another country.

To find comparative advantage, we must first calculate opportunity costs.

Opportunity Cost

The textbook definition of opportunity cost is the benefit of the next best alternative foregone.

In the context of international trade, we can think of opportunity cost as a calculation of how many units of one good we must give up to produce one unit of the other good.

For example, the opportunity cost of Good A in Country 1 is the number of units of Good B that this country has to give up to produce one more unit of Good A.

A helpful way to do this is to consider how many units of Good B a country must sacrifice to produce only Good A. In the example above, Country 1 can choose to produce 10 units of Good B if they produce 0 units Good A. Alternatively, the country could produce 5 units of Good A if they produce 0 units of Good B. So, in deciding to produce 5 units of Good A, they must give up 10 units of Good B. In other words, producing 1 unit of Good A costs this county 10/5 = 2 units of Good B. Hence, we can say the opportunity cost for producing Good A in Country 1 is 2 units of Good B.

We can simplify this using the following formula:

Opportunity Cost of Good A = Max Production of Good B / Max Production of Good A

Using this formula, you should be able to calculate the opportunity costs for producing the goods in the two countries above. You can summarise them in a table below:

When finished you can check your work by clicking here:

Summary

You now have all the information you need to fill in the summary table below:

These are the methods to find each type of advantage:

Comparative advantage: for each good, state which country has the lower opportunity cost.
Absolute advantage: for each good, state which country can produce more of the good (per worker).

You can click here to highlight the data above for the corresponding sections of the summary table:

You can click here to fill in the summary table:

Summary Questions:

Play around with the data by changing the figures in the original table. Try different situations by having new random initial values. Then answer these questions:

Is it possible for a country to have comparative advantage in both goods? Explain.
Is it possible for a country to have absolute advantage in both goods? Explain what the PPFs would need to look like for this to happen.
If a country has absolute advantage in a good, will that country automatically have comparative advantage in that good? Explain.
As the opportunity cost for Good A in Country 1 decreases, what happens to the opportunity cost for Good B in Country 1?
Describe the conditions that will lead to neither country having absolute advantage in the production of a good. Change the data to show this on the PPF.
Describe the conditions that will lead to neither country having comparative advantage in the production of a good. Change the data to show this on the PPF.