Short on time? This page is the recap. For explanations and worked examples, use the full study guide.
Recap
- Absolute advantage: a producer makes more of a good than another producer with the same resources.
- Comparative advantage: a producer makes a good at a lower opportunity cost than another producer.
- A producer can have an absolute advantage in both goods, but not a comparative advantage in both (two goods, two producers).
- Each side should specialise in its comparative-advantage good and trade for the other.
- With mutually beneficial terms of trade, both sides consume outside their own PPC. The PPCs themselves do not move.
Key relationships
| Data type | Absolute advantage | Opportunity cost of 1 unit of X |
|---|---|---|
| Output (units made with all resources, or PPC intercepts) | larger number | max Y ÷ max X (other good on top) |
| Input (hours or resources per unit) | smaller number | hours per X ÷ hours per Y (same good on top) |
| Idea | Rule |
|---|---|
| Comparative advantage | lower opportunity cost |
| Mutually beneficial terms for 1 X | more than the seller’s opportunity cost, less than the buyer’s |
| Gain per unit traded | buyer: own cost − price paid; seller: price received − own cost |
| Straight-line PPC | constant opportunity cost = size of the slope |
Assumptions behind the numbers
- Two producers, two goods, straight-line PPCs (constant opportunity cost).
- Both producers have the same quantity of resources (or the same time) in output tables.
- No transport costs or trade barriers.
- Equal opportunity costs mean no comparative advantage and no gains from trade.
Mistakes to avoid
- Deciding comparative advantage by who makes more. That is absolute advantage.
- Using the output rule on input data, or the reverse.
- Writing the opportunity cost upside down. Say: “1 X costs ___ Y.”
- Choosing terms outside the range, or exactly equal to one opportunity cost (no gain for that side).
- Saying trade shifts the PPC. Trade changes consumption, not production possibilities.
- Claiming one producer has a comparative advantage in both goods.
Quick self-check
- Country A can make 50 shirts or 25 bags; country B can make 30 shirts or 10 bags. What is each country’s opportunity cost of 1 bag? (A: 2 shirts; B: 3 shirts)
- Who has the comparative advantage in bags, and in shirts? (A in bags; B in shirts)
- State the range of mutually beneficial terms for 1 bag. (more than 2 but fewer than 3 shirts)
- A potter needs 2 hours per pot and 4 hours per vase. What is her opportunity cost of 1 vase? (2 pots)
Next: practice questions.