- Comparative advantage, specialization, and gains from trade
- Comparative advantage and absolute advantage
- Opportunity cost and comparative advantage using an output table
- Terms of trade and the gains from trade
- Input approach to determining comparative advantage
- When there aren't gains from trade
- Comparative advantage worked example
- Lesson summary: Comparative advantage and gains from trade
- Comparative advantage and the gains from trade
In this video, we use the PPCs for two different countries that each produce two goods in order to create an output table based on the data in the graph. We then use the output table to determine the opportunity costs of producing each good. Finally, we determine which country has a comparative advantage in each good.
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- What if the company/country produces only one good? Would it have no opportunity cost?(10 votes)
- Everything has an opportunity cost! For example, suppose a country only produced cars. Then the opportunity cost would something it could be producing instead using the same resources (like motorcycles or trucks).(21 votes)
- What if the country could produce only 6 basketballs, the opportunity cost would be 1.
So which country would have a comparative advantage? Because in this scenario the country A would always produce more.(4 votes)
- Neither would have a comparative advantage because their opportunity costs would be the same. 6b = 6s. Solve for basketballs and you get 1s which is the same as country B.
Comparative advantage only compares the opportunity costs of each country, so it doesn't matter how much each country can actually produce. If we were talking about absolute advantage it would be a different story as absolute advantage compares how much they can actually produce (not their opportunity costs).(5 votes)
- When calculating opportunity cost, do we assume that both goods have the same monetary value? For example, one shoe might be the same monetary cost of four basketballs.(1 vote)
- Opportunity cost is not just about monetary cost. It is the loss of potential gain from other alternatives when one alternative is chosen. For example, if a farmer chooses to plant corn, the opportunity cost is a different crop, like wheat being planted. When calculating opportunity cost, we take into account production quantity (when calculating with a PPC). For example, when a producer increases their production of a good A from 10 to 11 good A, they go from making 9 other goods (B) to 6 other good B. The 1-unit increase in producing good A means that its opportunity cost is 3 B, even if they were the same monetary cost.(1 vote)
- If a country has the same comparative advantages but an absolute advantage on both of it's products over another country. Then how do they go about trading their merchandise?(1 vote)
- [Tutor] What we're going to do in this video is draw a connection between the idea of opportunity cost of producing a good in a certain country and comparative advantage between countries in a certain good and below, right over here we have a chart, that shows production possibility curves for two different countries and as we see in many economic models, this is a, I would argue oversimplified model, but it helps us get some insights, where in each country workers can only produce some combination of sneakers and basketballs and to help us understand this and to appreciate that you can see this information in multiple ways, let's present this also as an output table, output table, which you will sometimes see and from either the production possibility curves or from the output table, we can calculate the opportunity costs of shoes and the opportunity costs of basketballs and then try to deduce some things about comparative advantage. So in an output table, we would look at country A and we would look at country B and we would think about, well, what is the max, and I'll just draw it, what is the max basketballs and this is all per worker per day and we would also think what is the max shoes, shoes, those look like socks, but you get the idea, once again, per worker per day and so let me draw a little chart here, so we can do that and so what I'd like you to do is pause this video and see if you can fill in this chart, what is the maximum basketballs per worker per day in country A and then in country B and then do the same thing for shoes. Alright, now let's work this together, so first in country A, what is the maximum number of basketballs? Well, if in country A, they put all of their energy into basketballs, we are right over here on the production possibilities curve, they can produce eight basketballs and if on the other end of the curve, they put all of their energy into shoes, they would produce no basketballs and six pairs of shoes, we're assuming that these are pairs of shoes, that we're talking about, six pairs of shoes and similarly if we go to company, (laughs) if we go to country B, I keep saying company, instead of country, if we go to country B, if we say what's the maximum number of basketballs, well, if they put all their energy into basketballs, we get four basketballs and no pairs of shoes, so that's four basketballs, but then if they put all of their energy into pairs of shoes, they produce no basketballs, they could produce four pairs of shoes and so it's as simple as that, this output table is just showing the extremes from the production possibility curves for these countries. Now with the information about the output table and these production possibility curves, let's calculate the opportunity cost, so let me set up another table and let me just say this is going to be our opportunity cost table, OC, not Orange County, opportunity costs and once again, it's going to be for country A and country B and we're gonna think about the opportunity costs of producing basketballs and that's gonna be in terms of pairs of shoes and then the opportunity costs for producing pairs of shoes and that's going to be in terms of basketballs and so let me set up another table and so I encourage you once again, pause this video and see if you can fill in this table, what is the opportunity costs? We'll start with what's the opportunity costs for producing basketballs in terms of shoes in country A? Alright, well there's a couple of ways to think about it, imagine a world in country A, where you're producing no basketballs and you're producing six pairs of shoes, but then if you were to increase the number of basketballs you produce by eight, so if you add eight basketballs, well, you're gonna give up six pairs of shoes, you see that right over here, you give up six pairs of shoes and so in country A eight basketballs cost six shoes, let me write that down, so in country A, eight basketballs and I'll just say B for short, cost six, six S, S is shoes for short, or another way to think about it, if you divide both of these by eight, one basketball costs six over eight shoes, all I did was eight basketballs cost six shoes and one basketball's gonna cost six divided by eight pairs of shoes and so what is that gonna be? Well, six over eight is the same thing as three fourths or three fourths of a pair of shoes, so one basketball costs three fourths of a pair of shoes or we could say that as 0.75 S, where S is a pair of shoes for this is my simplified notation and what about in country B? Well, in country B, if I go from no basketballs to four basketballs, then I would have given up four pairs of shoes, I would have given up four pairs of shoes, so in country B, so in B, four, four basketballs cost four pairs of shoes or divide both by four, you could have a basketball, one basketball costs one pair of shoes, so a basketball here in country B costs one pair of shoes, so one pair of shoes, S once again is a pair of shoes and you could have also gotten it from this information here, you could set up an equation, you could say look, if I put all of, in country A, if I put, so let's look at this part right over here, you could say in country A, if I put all of my energy into basketballs, I could produce eight basketballs, but if I put that same energy into shoes, I could produce six pairs of shoes, so with the same energy, I could produce either one of these and then if I want the opportunity costs for basketballs, I divide both by eight and that's essentially what I did over here and I get a basketball, it costs six eighths of a pair of shoes or three fourths of a pair of shoes, which is exactly what I have over here. Now let's do the opportunity cost for a pair of shoes in either country, well, there's a couple of ways to think about it, you could just view it as the reciprocal or you could even go back to this equation right over here, if we are in country A, we would say six shoes, if we put all our energy in shoes, we could produce six of them or six pairs of shoes, I should say and if we put all of our energy into basketballs, we could produce eight basketballs, but if you divide by six, you get per pair of shoes and so per each pair of shoes, the energy to produce one pair of shoes is equivalent to the energy to produce eight sixths of a basketball and eight sixths is the same thing as four thirds of a basketball and if we wanted to write it as a decimal just for simplicity or maybe to make it easier to compare, we would say that this is approximately 1.33, obviously the 3s just keep going on, it repeats forever, but approximately 1.33 basketballs is the cost of producing a shoe and the opportunity cost of producing a shoe in country A, 1.33 basketballs and what about in country B? Well, in country B we could set up a similar type of equation, where the same energy for four shoes, I could produce four basketballs and that's essentially what we set up right over here on the left, you divide both sides by four, the energy of a shoe is equal to the energy of a basketball, or I should say the energy of a pair of shoes is equal to the energy of making a basketball, so the opportunity cost of making a pair of shoes is equal to one basketball. So now we're ready to draw the connection, given the opportunity costs that we calculated, what country has the comparative advantage in basketballs? Pause this video and try to figure it out. So now let's look at the opportunity cost of producing a basketball in either country. In country A, each basketball costs a worker three fourths of a pair of shoes, while in country B, it costs them a whole pair of shoes, so country A actually has a lower opportunity cost of producing basketballs and so it has the comparative advantage here, comparative, comparative advantage and then if we look at shoes, it goes the other way around, country A has an opportunity cost of one and one third basketballs for every pair of shoes, while country B has an opportunity cost of only one basketball per pair of shoes, so it has a lower opportunity cost and this one actually might be a little bit counterintuitive, because if you look on the shoe axis right over here, country A has the absolute advantage in producing shoes, a worker per day in country A can produce six pairs of shoes, while a worker in country B can only produce four pairs of shoes, but even though country A has the absolute advantage, it would actually make sense for country A to focus on basketballs, while country B focuses on shoes and in the next video, we'll see how they can trade with each other to get to a scenario, that is beyond their production possibility curves and why focusing on your comparative advantage, at least in this theoretical, very simplified world, makes sense.