From the Ppfs Shown Above It Can Be Determined That the Opportunity Cost of Oil Is Lower in Country
What Happens When a Country Has an Absolute Reward in All Goods
What happens to the possibilities for merchandise if one country has an absolute advantage in everything? This is typical for high-income countries that often have well-educated workers, technologically advanced equipment, and the most up-to-date production processes. These loftier-income countries can produce all products with fewer resource than a depression-income state. If the high-income country is more productive across the board, will in that location still be gains from trade? Good students of Ricardo understand that trade is almost mutually beneficial substitution. Even when one land has an absolute advantage in all products, trade can however benefit both sides. This is because gains from trade come from specializing in one's comparative advantage.
Product Possibilities and Comparative Advantage
Consider the instance of merchandise betwixt the United States and Mexico described in Tabular array 19.ane. In this example, it takes four U.Due south. workers to produce ane,000 pairs of shoes, simply it takes five Mexican workers to do then. It takes one U.S. worker to produce ane,000 refrigerators, but information technology takes four Mexican workers to practise so. The U.s.a. has an absolute reward in productivity with regard to both shoes and refrigerators; that is, it takes fewer workers in the United states than in Mexico to produce both a given number of shoes and a given number of refrigerators.
| Land | Number of Workers needed to produce ane,000 units — Shoes | Number of Workers needed to produce 1,000 units — Refrigerators |
|---|---|---|
| United States | iv workers | 1 worker |
| Mexico | v workers | iv workers |
Accented advantage simply compares theproductivity of a worker between countries. It answers the question, "How many inputs do I demand to produce shoes in Mexico?" Comparative advantage asks this same question slightly differently. Instead of comparing how many workers information technology takes to produce a good, it asks, "How much am I giving upward to produce this good in this country?" Another way of looking at this is that comparative advantage identifies the good for which the producer's accented advantage is relatively larger, or where the producer'south absolute productivity disadvantage is relatively smaller. The Usa can produce 1,000 shoes with four-fifths as many workers as Mexico (four versus five), simply it can produce 1,000 refrigerators with only 1-quarter as many workers (one versus four). So, the comparative advantage of the Us, where its absolute productivity advantage is relatively greatest, lies with refrigerators, and Mexico's comparative reward, where its absolute productivity disadvantage is least, is in the production of shoes.
Mutually Beneficial Trade with Comparative Advantage
When nations increase product in their area of comparative advantage and trade with each other, both countries tin can benefit. Over again, the production possibility frontier is a useful tool to visualize this benefit.
Consider a state of affairs where the U.s. and United mexican states each have 40 workers. For instance, as Table 19.2 shows, if the United States divides its labor so that 40 workers are making shoes, so, since information technology takes 4 workers in the United states of america to make ane,000 shoes, a total of 10,000 shoes will exist produced. (If iv workers can make 1,000 shoes, then forty workers will make 10,000 shoes). If the 40 workers in the United States are making refrigerators, and each worker tin produce one,000 refrigerators, then a total of forty,000 refrigerators will be produced.
Refrigerator Production — using forty workers
| Country | Shoe Production — using 40 workers | ||
|---|---|---|---|
| U.s.a. | 10,000 shoes | or | xl,000 refrigerators |
| United mexican states | 8,000 shoes | or | 10,000 refrigerators |
Figure 19.1. Product Possibility Frontiers. (a) With xl workers, the United States tin produce either 10,000 shoes and cipher refrigerators or 40,000 refrigerators and nil shoes. (b) With 40 workers, United mexican states can produce a maximum of eight,000 shoes and goose egg refrigerators, or 10,000 refrigerators and nil shoes. All other points on the production possibility line are possible combinations of the ii goods that can be produced given current resources. Indicate A on both graphs is where the countries start producing and consuming before merchandise. Indicate B is where they end up after trade.
As ever, the gradient of the production possibility frontier for each land is the opportunity costs as labor is transferred from shoe production to refrigerators, or vice versa (run across Figure 19.ane).
Let's say that, in the state of affairs earlier trade, each nation prefers to produce a combination of shoes and refrigerators that is shown at betoken A. Table 19.3 shows the output of each good for each country and the total output for the ii countries.
| Country | Current Shoe Production | Current Fridge Production |
|---|---|---|
| United states | 5,000 | 20,000 |
| Mexico | 4,000 | five,000 |
| Total | 9,000 | 25,000 |
Continuing with this scenario, each country transfers some corporeality of labor toward its area of comparative advantage. For example, the United States transfers six workers abroad from shoes and toward producing refrigerators. As a result, U.Southward. production of shoes decreases past ane,500 units (6/four × ane,000), while its production of refrigerators increases past six,000 (that is, 6/1 × one,000). United mexican states also moves production toward its area of comparative advantage, transferring 10 workers away from refrigerators and toward production of shoes. As a result, product of refrigerators in Mexico falls past ii,500 (10/4 × ane,000), but production of shoes increases past 2,000 pairs (x/5 × 1,000). Notice that when both countries shift production toward each of their comparative advantages (what they are relatively better at), their combined production of both goods rises, equally shown in Table nineteen.4. The reduction of shoe production by 1,500 pairs in the United States is more than commencement past the gain of two,000 pairs of shoes in United mexican states, while the reduction of two,500 refrigerators in United mexican states is more than offset by the additional 6,000 refrigerators produced in the United States.
| Country | Shoe Product | Refrigerator Product |
|---|---|---|
| United States | iii,500 | 26,000 |
| Mexico | half-dozen,000 | 2,500 |
| Total | 9,500 | 28,500 |
This numerical case illustrates the remarkable insight of comparative reward: even when 1 country has an absolute advantage in all appurtenances and another land has an absolute disadvantage in all goods, both countries tin still benefit from trade. Even though the United States has an accented advantage in producing both refrigerators and shoes, it makes economic sense for it to specialize in the proficient for which information technology has a comparative advantage. The United States will export refrigerators and in return import shoes.
How Opportunity Cost Sets the Boundaries of Trade
This case shows that both parties can benefit from specializing in their comparative advantages and trading. By using the opportunity costs in this example, information technology is possible to identify the range of possible trades that would benefit each country.
United mexican states started out, before specialization and merchandise, producing four,000 pairs of shoes and five,000 refrigerators (run into Figure 19.i and Table nineteen.3). And then, in the numerical case given, Mexico shifted production toward its comparative advantage and produced vi,000 pairs of shoes just simply two,500 refrigerators. Thus, if Mexico tinexport no more than 2,000 pairs of shoes (giving up ii,000 pairs of shoes) in exchange for imports of at least 2,500 refrigerators (a gain of 2,500 refrigerators), it will be able to consume more of both goods than before trade. Mexico will be unambiguously better off. Conversely, the United States started off, before specialization and merchandise, producing 5,000 pairs of shoes and 20,000 refrigerators. In the example, it and then shifted product toward its comparative reward, producing only 3,500 shoes but 26,000 refrigerators. If the U.s. can export no more 6,000 refrigerators in commutation for imports of at least 1,500 pairs of shoes, it will be able to consume more than of both appurtenances and will be unambiguously better off.
The range of trades that tin can benefit both nations is shown in Tabular array 19.five. For case, a trade where the U.S. exports 4,000 refrigerators to Mexico in exchange for 1,800 pairs of shoes would benefit both sides, in the sense that both countries would be able to consume more of both appurtenances than in a world without trade.
| The U.S. economy, subsequently specialization, will benefit if it: | The Mexican economic system, later on specialization, will benefit if it: |
|---|---|
| Exports fewer than 6,000 refrigerators | Imports at to the lowest degree 2,500 refrigerators |
| Imports at to the lowest degree 1,500 pairs of shoes | Exports no more than than two,000 pairs of shoes |
Merchandise allows each country to accept advantage of lower opportunity costs in the other country. If Mexico wants to produce more than refrigerators without trade, it must face up its domestic opportunity costs and reduce shoe production. If Mexico, instead, produces more shoes and and then trades for refrigerators fabricated in the U.s.a., where theopportunity cost of producing refrigerators is lower, United mexican states can in result take reward of the lower opportunity cost of refrigerators in the Usa. Conversely, when the United states of america specializes in its comparative advantage of refrigerator production and trades for shoes produced in Mexico, international trade allows the United States to have reward of the lower opportunity price of shoe product in Mexico.
The theory of comparative advantage explains why countries trade: they have dissimilar comparative advantages. It shows that the gains from international merchandise result from pursuing comparative reward and producing at a lower opportunity cost. The following feature shows how to summate absolute and comparative reward and the way to apply them to a country's production.
Computing Absolute and Comparative Advantage
In Canada a worker tin can produce 20 barrels of oil or 40 tons of lumber. In Venezuela, a worker can produce 60 barrels of oil or thirty tons of lumber.
Lumber(tons)
| Tabular array nineteen.vi | |||
| Land | Oil(barrels) | ||
| Canada | 20 | or | twoscore |
| Venezuela | sixty | or | xxx |
- Who has the absolute reward in the production of oil or lumber? How tin can you tell?
- Which country has a comparative advantage in the production of oil?
- Which country has a comparative advantage in producing lumber?
- In this instance, is accented advantage the same as comparative reward, or not?
- In what production should Canada specialize? In what production should Venezuela specialize?
Step ane. Brand a table like Table 19.6.
Pace 2. To calculate absolute advantage, expect at the larger of the numbers for each production. Ane worker in Canada tin produce more lumber (twoscore tons versus thirty tons), then Canada has the absolute advantage in lumber. I worker in Venezuela can produce 60 barrels of oil compared to a worker in Canada who can produce only 20.
Step three. To calculate comparative reward, find the opportunity toll of producing one barrel of oil in both countries. The country with the lowest opportunity toll has the comparative reward. With the same labor time, Canada can produce either 20 barrels of oil or twoscore tons of lumber. And so in result, 20 barrels of oil is equivalent to 40 tons of lumber: twenty oil = 40 lumber. Divide both sides of the equation past 20 to summate the opportunity cost of one butt of oil in Canada. 20/xx oil = 40/20 lumber. 1 oil = ii lumber. To produce ane additional barrel of oil in Canada has an opportunity cost of 2 lumber. Summate the same way for Venezuela: 60 oil = xxx lumber. Split up both sides of the equation by sixty. 1 oil in Venezuela has an opportunity price of one/3 lumber. Because 1/3 lumber < 2 lumber, Venezuela has the comparative reward in producing oil.
Stride iv. Summate the opportunity cost of one lumber past reversing the numbers, with lumber on the left side of the equation. In Canada, 40 lumber is equivalent in labor fourth dimension to 20 barrels of oil: 40 lumber = 20 oil. Carve up each side of the equation by xl. The opportunity toll of one lumber is i/2 oil. In Venezuela, the equivalent labor time will produce xxx lumber or 60 oil: 30 lumber = 60 oil. Divide each side by thirty. 1 lumber has an opportunity price of 2 oil. Canada has the lower opportunity price in producing lumber.
Footstep 5. In this example, absolute advantage is the aforementioned as comparative reward. Canada has the absolute and comparative advantage in lumber; Venezuela has the absolute and comparative advantage in oil.
Step half-dozen. Canada should specialize in what information technology has a relative lower opportunity cost, which is lumber, and Venezuela should specialize in oil. Canada will be exporting lumber and importing oil, and Venezuela will be exporting oil and importing lumber.
Comparative Advantage Goes Camping ground
To build an intuitive understanding of how comparative advantage tin benefit all parties, gear up aside examples that involve national economies for a moment and consider the situation of a group of friends who decide to go camping together. The six friends have a wide range of skills and experiences, but ane person in particular, Jethro, has done lots of camping before and is likewise a great athlete. Jethro has an absolute advantage in all aspects of camping: he is faster at conveying a backpack, gathering firewood, paddling a canoe, setting up tents, making a meal, and washing upwards. So here is the question: Because Jethro has an absolute productivity advantage in everything, should he do all the work?
Of grade non! Even if Jethro is willing to piece of work like a mule while anybody else sits around, he, like most mortals, only has 24 hours in a solar day. If everyone sits around and waits for Jethro to exercise everything, not merely volition Jethro exist an unhappy camper, but there will not be much output for his group of half-dozen friends to consume. The theory of comparative advantage suggests that anybody will benefit if they effigy out their areas of comparative advantage—that is, the area of camping where their productivity disadvantage is to the lowest degree, compared to Jethro. For example, it may exist that Jethro is lxxx% faster at edifice fires and cooking meals than anyone else, but but 20% faster at gathering firewood and 10% faster at setting up tents. In that case, Jethro should focus on edifice fires and making meals, and others should attend to the other tasks, each according to where their productivity disadvantage is smallest. If the campers coordinate their efforts according to comparative advantage, they can all gain.
Source: https://courses.lumenlearning.com/suny-macroeconomics/chapter/reading-absolute-advantage-2/
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