33.1 Absolute and comparative advantage  (Page 3/15)

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Production before trade
Country Oil Production (barrels) Corn Production (bushels)
Saudi Arabia (C) 60 10
United States (C') 20 60
Total World Production 80 70

The slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn. Using all its resources, the United States can produce 50 barrels of oil or 100 bushels of corn. So the opportunity cost of one barrel of oil is two bushels of corn—or the slope is 1/2. Thus, in the U.S. production possibility frontier graph, every increase in oil production of one barrel implies a decrease of two bushels of corn. Saudi Arabia can produce 100 barrels of oil or 25 bushels of corn. The opportunity cost of producing one barrel of oil is the loss of 1/4 of a bushel of corn that Saudi workers could otherwise have produced. In terms of corn, notice that Saudi Arabia gives up the least to produce a barrel of oil. These calculations are summarized in [link] .

Opportunity cost and comparative advantage
Country Opportunity cost of one unit — Oil (in terms of corn) Opportunity cost of one unit — Corn (in terms of oil)
Saudi Arabia ¼ 4
United States 2 ½

Again recall that comparative advantage was defined as the opportunity cost of producing goods. Since Saudi Arabia gives up the least to produce a barrel of oil, ( $\frac{\text{1}}{\text{4}}$  <  $\text{2}$ in [link] ) it has a comparative advantage in oil production. The United States gives up the least to produce a bushel of corn, so it has a comparative advantage in corn production.

In this example, there is symmetry between absolute and comparative advantage. Saudi Arabia needs fewer worker hours to produce oil (absolute advantage, see [link] ), and also gives up the least in terms of other goods to produce oil (comparative advantage, see [link] ). Such symmetry is not always the case, as we will show after we have discussed gains from trade fully. But first, read the following Clear It Up feature to make sure you understand why the PPF line in the graphs is straight.

Can a production possibility frontier be straight?

When you first met the production possibility frontier (PPF) in the chapter on Choice in a World of Scarcity it was drawn with an outward-bending shape. This shape illustrated that as inputs were transferred from producing one good to another—like from education to health services—there were increasing opportunity costs. In the examples in this chapter, the PPFs are drawn as straight lines, which means that opportunity costs are constant. When a marginal unit of labor is transferred away from growing corn and toward producing oil, the decline in the quantity of corn and the increase in the quantity of oil is always the same. In reality this is possible only if the contribution of additional workers to output did not change as the scale of production changed. The linear production possibilities frontier is a less realistic model, but a straight line simplifies calculations. It also illustrates economic themes like absolute and comparative advantage just as clearly.

Gains from trade

Consider the trading positions of the United States and Saudi Arabia after they have specialized and traded. Before trade, Saudi Arabia produces/consumes 60 barrels of oil and 10 bushels of corn. The United States produces/consumes 20 barrels of oil and 60 bushels of corn. Given their current production levels, if the United States can trade an amount of corn fewer than 60 bushels and receives in exchange an amount of oil greater than 20 barrels, it will gain from trade    . With trade, the United States can consume more of both goods than it did without specialization    and trade. (Recall that the chapter Welcome to Economics! defined specialization as it applies to workers and firms. Specialization is also used to describe the occurrence when a country shifts resources to focus on producing a good that offers comparative advantage.) Similarly, if Saudi Arabia can trade an amount of oil less than 60 barrels and receive in exchange an amount of corn greater than 10 bushels, it will have more of both goods than it did before specialization and trade. [link] illustrates the range of trades that would benefit both sides.

Questions & Answers

What is the difference between pure monopoly and natural monopoly
Joseph Reply
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Alex
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GODWIN Reply
what's the opportunity cost for free goods?
Bah
what is the demand and supply of QD is equal to 4040 thousand
Prince Reply
uses and limitations of elasticity of demand concept
Tinodaishe
Elasticity of demand refers to the degree of responsiveness of quantities
grace Reply
Thanks
Ogbonna
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Ogbonna
I need all the formula for elasticity of demand
Dogbeda Reply
%∆QD/%∆P formula for elasticity of demand
divine
for that of income elasticity %∆QD / %∆I
divine
and that of cross elasticity of demand %∆QDx / %∆Py
divine
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Joycelyn Reply
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factors affecting demand and supply
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Sanni
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Mary
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Francis Reply
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Khalfan
what is the demand and supply of Qd=40,000-6P Qs=14P-28,000 the equilibrium price
Rocky Reply
3400
Ram
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Olowe
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Collins
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Ram
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Thandolwethu Reply
it controls only price or production not both a same time
Ram
Difference between demand and supply
Kareem Reply
demand talks about the consumers and supply also talks about producers
Bright
demand talks about the relationship between price and the quantity demanded for a certain goods and supply talks about the relationship between price and quantity supply of a certain goods .
Mutala
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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