Comparative Advantage

Name: _________________________________

International trade is based upon the principle that all countries gain from trade.

Maximum Production Possibilities for the US and Mexico:

	US	Mexico
computers	50	10
TVs	50	40

1 year of labor by one worker in U.S. can either produce 50 computers or 50 TVs

1 year of labor in Mexico can either produce 10 computers or 40 TVs

But we need to judge by relative rather than absolute terms!

Each country's climate, labor force, and geography make it a relatively efficient producer of some goods and an inefficient producer of others.

Numbers above are the total amount that can be produced, but does not tell us the COST at which they are produced!

...meaning opportunity cost...

Opportunity Cost of Producing Computers:

US:cost of 1 computer = 1 TV

Mexico:cost of 1 computer = 4 TVs

Opportunity Cost of Producing TVs:

US: cost of 1 TV = 1 computer

Mexico: cost of 1 TV = 1/4 computer

Comparative Advantage:One country has a lower opportunity cost in producing an item.

US has comparative advantage in computers (costs less in terms of TVs).

Mexico has comparative advantage in TVs (costs less in terms of computers).

US will produce computers and Mexico will produce TVs and the two countries will trade!

PROBLEMS: Determine which of the following countries has absolute advantage and which has comparative advantage:

1. Maximum Production Possibilities for Japan and Switzerland:

	Japan	Switzerland
Chocolate	100 bars	600 bars
Cell Phones	100	110

1 year of labor by one worker in Japan can either produce 100 bars of chocolate or 100 cell phones

1 year of labor in Switzerland can either produce 600 bars of chocolate or 110 cell phones

What is the opportunity cost in Japan for producing 1 bar of chocolate?

What is the opportunity cost in Japan for producing 1 cell phone?

What is the opportunity cost in Switzerland for producing 1 bar of chocolate? (hint: divide cell phones by chocolate)

What is the opportunity cost in Switzerland for producing 1 cell phone? (hint: divide chocolate by cell phones)

What country has absolute advantage in cell phones?

Which country has absolute advantage in chocolate?

Which country has comparative advantage in cell phones?

Which country has comparative advantage in chocolate?

What would you recommend Japan to produce?

What would you recommend Switzerland to produce?

1. Maximum Production Possibilities for Iceland and Italy:

	Iceland	Italy
Fish	500 lbs	250 lbs
Leather Shoes	2000 prs	2500 pairs

1 year of labor by one worker in Iceland can either produce 500 pounds of fish or 2000 pairs of leather shoes

1 year of labor in Italy can either produce 250 pounds of fish or 2500 pairs of leather shoes

What is the opportunity cost in Iceland for producing 1 pound of fish?

What is the opportunity cost in Iceland for producing 1 pair of leather shoes?

What is the opportunity cost in Italy for producing 1 pound of fish?

What is the opportunity cost in Italy for producing 1 pair of leather shoes?

What country has absolute advantage in fish?

Which country has absolute advantage in leather shoes?

Which country has comparative advantage in fish?

Which country has comparative advantage in leather shoes?

What would you recommend Iceland to produce?

What would you recommend Italy to produce?