A country might have an absolute advantage in producing some goods due to its natural resources, climate conditions and so on. So here is the question: Because Jethro has an absolute productivity advantage in everything, should he do all the work? What if a country has no comparative advantage? 109. Germany has an absolute advantage in the production of both goods. Trade allows each country to take advantage of lower opportunity costs in the other country. Because they have no advantage, they cannot benefit from trade.” How would you respond? One oil in Venezuela has an opportunity cost of 1/2 lumber. How does comparative advantage lead to gains from trade? Absolute advantage simply compares the productivity of a worker between countries. One lumber has an opportunity cost of two oil. It shows that the gains from international trade result from pursuing comparative advantage and producing at a lower opportunity cost. Comparative Advantage 8. If Country A has an absolute advantage in the production of two goods, compared to Country B, then it is in the best interest of both countries to trade. The range of trades that can benefit both nations is shown in Table 12. Step 6. 34 - Why must voluntary trade between two countries be... Ch. Even if Jethro is willing to work like a mule while everyone else sits around, he, like most mortals, only has 24 hours in a day. Consider the example of trade between the United States and Mexico described in Table 8. In what product should Japan specialize? Step 5. If the United States can export no more than 6,000 refrigerators in exchange for imports of at least 1,500 pairs of shoes, it will be able to consume more of both goods and will be unambiguously better off. Shifting those three German workers will reduce video camera production by 3/4 of a camera. Continuing with this scenario, each country transfers some amount of labor toward its area of comparative advantage. What about corn? If Mexico, instead, produces more shoes and then trades for refrigerators made in the United States, where the opportunity cost of producing refrigerators is lower, Mexico can in effect take advantage of the lower opportunity cost of refrigerators in the United States. This is because gains from trade come from specializing in one’s comparative advantage. This example shows that both parties can benefit from specializing in their comparative advantages and trading. In this example, is absolute advantage the same as comparative advantage, or not? Assume that the Canadians specialize completely because they figured out they have a comparative advantage in lumber. Absolute advantage is a scenario where a business or a country is wholly sufficient to continuously produce a higher quality product at better rates compared to others. It takes one U.S. worker to produce 1,000 refrigerators, but it takes four Mexican workers to do so. In Malaysia, one worker can make 10 tons of rubber or 40 radios. Logically it all comes down to productivity ratios, as one country can produce more output with fewer inputs. By using the opportunity costs in this example, it is possible to identify the range of possible trades that would benefit each country. Poverty and Economic Inequality, Introduction to Poverty and Economic Inequality, 14.4 Income Inequality: Measurement and Causes, 14.5 Government Policies to Reduce Income Inequality, Chapter 15. When a country has a comparative advantage in producing certain items, it means the nation can make the products at a lower cost than other countries. Which country has a comparative advantage in producing lumber? So, the comparative advantage of the United States, where its absolute productivity advantage is relatively greatest, lies with refrigerators, and Mexico’s comparative advantage, where its absolute productivity disadvantage is least, is in the production of shoes. Government Budgets and Fiscal Policy, Introduction to Government Budgets and Fiscal Policy, 30.3 Federal Deficits and the National Debt, 30.4 Using Fiscal Policy to Fight Recession, Unemployment, and Inflation, 30.6 Practical Problems with Discretionary Fiscal Policy, Chapter 31. In this example, does each country have an absolute advantage and a comparative advantage in the same good? The United States can produce 1,000 shoes with four-fifths as many workers as Mexico (four versus five), but it can produce 1,000 refrigerators with only one-quarter as many workers (one versus four). Calculate the opportunity cost of producing one video camera in Germany and in Poland. In this example, does each country have an absolute advantage and a comparative advantage in the same good? Which country has a comparative advantage in the production of radios? How can you tell? For example, the United States transfers six workers away from shoes and toward producing refrigerators. C. What is Jamaica’s opportunity cost for producing one unit of bananas? In Canada a worker can produce 20 barrels of oil or 40 tons of lumber. Which country has a comparative advantage in producing lumber? In this example, absolute advantage differs from comparative advantage. Mark a point on their production possibilities where they can get at least 3,000 tons. The above statement is false. Step 2. 20/20 oil = 40/20 lumber. Step 4. Again, the production possibility frontier is a useful tool to visualize this benefit. This column investigates why Japan lost this comparative advantage. In Venezuela, the equivalent labor time will produce 30 lumber or 60 oil: 30 lumber = 60 oil. Producing a video camera in Poland requires 12 workers, and shifting those 12 workers away from television production has an opportunity cost of two television sets. All your roommates, however, are slackers and do not clean up after themselves. Can you imagine a trade-related analogy to this problem? Let’s say that, in the situation before trade, each nation prefers to produce a combination of shoes and refrigerators that is shown at point A. Explain how you arrive at that answer. This numerical example illustrates the remarkable insight of comparative advantage: even when one country has an absolute advantage in all goods and another country has an absolute disadvantage in all goods, both countries can still benefit from trade. Trade: The theory of comparative advantage shows us that a country doesn't need to be the best at producing a product to be producing it. In what product should Germany specialize? The following Work It Out feature shows how to calculate absolute and comparative advantage and the way to apply them to a country’s production. These high-income countries can produce all products with fewer resources than a low-income country. Which country has an absolute advantage in producing TVs? Gains from trade come about as a result of comparative advantage. As a result, production of refrigerators in Mexico falls by 2,500 (10/4 × 1,000), but production of shoes increases by 2,000 pairs (10/5 × 1,000). A) Oz has absolute advantage in producing TVs. (Your calculation may involve fractions, which is fine.) With the same labor time, Canada can produce either 20 barrels of oil or 40 tons of lumber. That it makes it possible for society to become better off by increasing In Japan, one worker can make 5 tons of rubber or 80 radios. Producing an additional television set in Poland requires six workers, and shifting those workers from the other good reduces output of video cameras by 6/12 of a camera, or 1/2. In this example, is absolute advantage the same as comparative advantage, or not? If the United States has an absolute and a comparative advantage in the production of apple pie, then: Canada must have the comparative advantage in the productive of skates Suppose that, given the same number of workers, the United States can produce two times as many TVs … The US has absolute and comparative advantage in Cars while Brazil has an absolute and comparative advantage in lumber If it takes one country one unit of labor to produce either a computer or a TV but it takes the other country two units of labor to produce a computer only one to produce a TV, then the first country They have poor soil, low investments in formal education and hence low-skill workers, no capital, and no natural resources to speak of. In Venezuela, a worker can produce 60 barrels of oil or 30 tons of lumber. One of the great benefits of trade isa. Draw a production possibilities frontier for each country. Is it possible to have a comparative advantage in the production of a good but not to have an absolute advantage? Absolute advantage is determined by comparing the absolute productivity in different countries of producing each good. Mexico Suppose the United States is currently producing 200 tons of hamburgers and 90 tons of tacos and Mexico is currently producing 40 tons of hamburgers and 50 tons of tacos. In Germany, it takes fewer workers to make either a television or a video camera. Which country has an absolute advantage in producing oil? Which country has a comparative advantage in the production of video cameras? The theory of comparative advantage explains why countries trade: they have different comparative advantages. Calculate the opportunity cost of producing 10 additional tons of rubber in Japan and in Malaysia. Is the Canadian “ask” you identified in (b) also beneficial for Venezuelans? Explain. Review the numbers for Canada and Venezuela from. France should shift production toward wine, export wine, and import sweaters. The United States has an absolute advantage 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. Canada has the absolute and comparative advantage in lumber; Venezuela has the absolute and comparative advantage in oil. You just got a job in Washington, D.C. You move into an apartment with some acquaintances. We will show an example with two countries. Canadians want at least 2,000 tons of lumber. If the 40 workers in the United States are making refrigerators, and each worker can produce 1,000 refrigerators, then a total of 40,000 refrigerators will be produced. Divide both sides of the equation by 60. To calculate comparative advantage, find the opportunity cost of producing one barrel of oil in both countries. Saudi Arabia can produce oil with fewer resources, while … Japanese exports in electronic parts and components dramatically fell in value after the Global Crisis and have not recovered until today. Which country has a comparative advantage in the production of oil? Preventing other countries form getting a comparative advantage by their use of environmentally irresponsible actions. If the campers coordinate their efforts according to comparative advantage, they can all gain. In this example, it takes four U.S. workers to produce 1,000 pairs of shoes, but it takes five Mexican workers to do so. The United States has an absolute advantage 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 sh… Preferences are the same in the two countries and are described by the following utility function: U(S, C) = 0.5 ln S + 0.5 ln C, where S and C refer to the consumption quantity of shoes and computers, respectively. Japan has absolute advantage in producing both fish and cloth because one worker can produce more of either goods in Japan. 2008. In the given time frame Country A can produce four times as much wheat or twice as many TV's. 60 Which country has an absolute advantage in producing tacos? Mexico will be unambiguously better off. What sorts of problems may this create? Producing a video camera in Germany requires four workers, and shifting those four workers away from television production has an opportunity cost of 4/3 television sets. It takes one U.S. worker to produce 1,000 refrigerators, but it takes four Mexican workers to do so. Features of Absolute Advantage. Bernstein, William J. Instead of comparing how many workers it takes to produce a good, it asks, “How much am I giving up 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 absolute advantage is relatively larger, or where the producer’s absolute productivity disadvantage is relatively smaller. For example, it may be that Jethro is 80% faster at building fires and cooking meals than anyone else, but only 20% faster at gathering firewood and 10% faster at setting up tents. In the example, it then shifted production toward its comparative advantage, producing only 3,500 shoes but 26,000 refrigerators. (If four workers can make 1,000 shoes, then 40 workers will make 10,000 shoes). 34 - Which country has the comparative advantage in... Ch. Why? To simplify, let’s say that Saudi Arabia and the United States each have 100 worker hours (see Table 19.2). Answer: Home has an absolute advantage in the production of bicycles because it is able to produce bicycles with fewer resources (more per hour) than Foreign. New York. c.Given Table 1 and your answer to Question 1a), explain which country has the comparative advantage in producing i) crude oil, and ii) refined oil. Who has the absolute advantage in the production of oil or lumber? Canada will be exporting lumber and importing oil, and Venezuela will be exporting oil and importing lumber. Issues in Labor Markets: Unions, Discrimination, Immigration, Introduction to Issues in Labor Markets: Unions, Discrimination, Immigration, Chapter 16. In that case, Jethro should focus on building fires and making meals, and others should attend to the other tasks, each according to where their productivity disadvantage is smallest. (Your calculation may involve fractions, which is fine.) Canada should specialize in what it has a relative lower opportunity cost, which is lumber, and Venezuela should specialize in oil. Which country has a comparative advantage in producing rubber? Calculate the opportunity cost of producing 10 additional tons of rubber in Japan and in Malaysia. You will need to include a definition in your own words of comparative advantage in your answer. Mexico also moves production toward its area of comparative advantage, transferring 10 workers away from refrigerators and toward production of shoes. b) Which country has absolute advantage in producing corn? 34 - Which country has the comparative advantage in... Ch. Assume you have the same number of hours to devote to cleaning. The If other countries specialize in the area of their comparative advantage as well and trade, the highly productive country is able to benefit from a lower opportunity cost of production in other countries. For example, as Table 9 shows, if the United States divides its labor so that 40 workers are making shoes, then, since it takes four workers in the United States to make 1,000 shoes, a total of 10,000 shoes will be produced. Divide each side of the equation by 40. Step 3. (a) Which country has an absolute advantage in producing Shoes? Explain using the data from the table. Divide each side by 30. If two countries each are currently producing two goods, and each begins to specialize in the good in which it has a comparative advantage, what will happen to total (world) output? Country Shirts TVs China 400 200 India 120 30 A. In Poland it takes six workers to make one television and 12 workers to make one video camera. How can you tell? In Canada, 40 lumber is equivalent in labor time to 20 barrels of oil: 40 lumber = 20 oil. c) What is the opportunity cost of producing a steel in Russia? In what product should Malaysia specialize? Monetary Policy and Bank Regulation, Introduction to Monetary Policy and Bank Regulation, 28.1 The Federal Reserve Banking System and Central Banks, 28.3 How a Central Bank Executes Monetary Policy, 28.4 Monetary Policy and Economic Outcomes, Chapter 29. Use the production possibilities frontier graph for Venezuela to show that Venezuelans can gain from trade. How much should they ask for if they want to gain from trading with Venezuela? Which jobs should you assign to your roommates to get the most free time overall? The six friends have a wide range of skills and experiences, but one person in particular, Jethro, has done lots of camping before and is also a great athlete. Even though the United States has an absolute advantage in producing both refrigerators and shoes, it makes economic sense for it to specialize in the good for which it has a comparative advantage. China B. Explain which country has the absolute advantage in each good and justify: 4: Compute comparative advantage for each good, show you work with correct notation: 2: 1 oil = 2 lumber. The reduction of shoe production by 1,500 pairs in the United States is more than offset by the gain of 2,000 pairs of shoes in Mexico, while the reduction of 2,500 refrigerators in Mexico is more than offset by the additional 6,000 refrigerators produced in the United States. Further assume that consumers in both countries desire both these goods. Producing an additional television in Germany requires three workers. If everyone sits around and waits for Jethro to do everything, not only will Jethro be an unhappy camper, but there will not be much output for his group of six friends to consume. Conversely, Poland should specialize, at least to some extent, in the production of televisions, export televisions, and import video cameras. Exchange Rates and International Capital Flows, Introduction to Exchange Rates and International Capital Flows, 29.1 How the Foreign Exchange Market Works, 29.2 Demand and Supply Shifts in Foreign Exchange Markets, 29.3 Macroeconomic Effects of Exchange Rates, Chapter 30. Which of the following are prominent imports into the US? In what product should Canada specialize? It is important for countries to have comparative and absolute advantages. Which country has the absolute advantage in sugarcane? b. Next: 33.3 Intra-industry Trade between Similar Economies, Creative Commons Attribution 4.0 International License, Show the relationship between production costs and comparative advantage, Identify situations of mutually beneficial trade, Identify trade benefits by considering opportunity costs. Atlantic Monthly Press. Which country has an absolute advantage in producing TVs? Explain how you got your answer? c. Which country has an absolute advantage in the production of snowboards? Which country has the absolute advantage in bananas? It seems that there is no need for Japan to trade because Japan can produce both more of both goods. Even when one country has an absolute advantage in all products, trade can still benefit both sides. In what product should Poland specialize? 34 - Which country has the absolute advantage in... Ch. These goods are homogeneous, meaning that consumers/producers cannot differentiate between corn or oil from either country. Even when a country has high levels of productivity in all goods, it can still benefit from trade. Thus, the opportunity cost of producing video cameras is lower in Germany, and video cameras will be Germany’s comparative advantage. In this example, absolute advantage is the same as comparative advantage. 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