Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Absolute advantage: a producer can make more of a good than another producer with the same resources (or the same amount with fewer resources).
- Comparative advantage: a producer can make a good at a lower opportunity cost than another producer.
- With two goods and two producers, each has the comparative advantage in a different good, unless their opportunity costs are equal (then no one does).
- Specialisation by comparative advantage gets more total output from the same resources (in typical question data, more of both goods). Trade shares the extra output.
- After trade, each side can consume outside its own PPC. The PPC itself does not move.
Key relationships
| Data type | Absolute advantage | Opportunity cost of 1 X |
|---|---|---|
| Output (units made) | larger number | output of Y ÷ output of X |
| Input (hours per unit) | smaller number | hours per X ÷ hours per Y |
| Idea | Rule |
|---|---|
| Two PPCs on one graph | higher intercept = absolute advantage in that good; flatter line = comparative advantage in the good on the horizontal axis |
| Mutually beneficial terms of trade | strictly between the two producers’ opportunity costs |
| Gain per unit traded | exporter: price received − own cost; importer: own cost − price paid |
Assumptions behind the model
- Two producers, two goods, fixed resources and technology.
- Constant opportunity cost (straight-line PPCs) in most questions.
- Transport costs and trade barriers are ignored.
Mistakes to avoid
- Deciding specialisation by absolute advantage.
- Using the output rule on input data, which gives the reciprocal.
- Saying one producer has the comparative advantage in both goods.
- Saying trade shifts the PPC outward.
- Giving terms of trade outside the range, or exactly at one end, as “beneficial”.
- Forgetting units: “2 sacks of rice per pair of shoes”, not just “2”.
Quick self-check
- Pella can make 10 kites or 20 drums with its resources. What is its opportunity cost of 1 kite? (20 ÷ 10 = 2 drums; 1 drum costs 1/2 kite.)
- A potter needs 4 hours per pot and 2 hours per vase. What is the opportunity cost of 1 pot? (4 ÷ 2 = 2 vases.)
- Producer X’s cost of a hat is 2 scarves and Producer Y’s is 5 scarves. Who exports hats, and what terms work for both? (X; 1 hat for more than 2 but fewer than 5 scarves.)
- Does a country that is worse at producing both goods gain from trade? (Yes, if its opportunity costs differ: it still has a comparative advantage in one good.)
Next: practice questions.