Question

Why does comparative advantage matter more than absolute advantage for trade? 

Why does the production possibilities frontier bow out?

 

Answer 1

1)Absolute Advantage Versus Comparative Advantage

Absolute advantage refers to differences in productivity of nations, while comparative advantage refers to differences in opportunity costs.

• The producer that requires a smaller quantity inputs to produce a good is said to have an absolute advantage in producing that good.
• Comparative advantage refers to the ability of a party to produce a particular good or service at a lower opportunity cost than another.
• The existence of a comparative advantage allows both parties to benefit from trading, because each party will receive a good at a price that is lower than its opportunity cost of producing that good.

Key Terms

• Absolute advantage: The capability to produce more of a given product using less of a given resource than a competing entity.
• comparative advantage: The ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.

· Absolute advantage compares the productivity of different producers or economies. The producer that requires a smaller quantity inputs to produce a good is said to have an absolute advantage in producing that good.

· The accompanying figure shows the amount of output Country A and Country B can produce in a given period of time. Country A uses less time than Country B to make either food or clothing. Country A makes 6 units of food while Country B makes one unit, and Country A makes three units of clothing while Country B makes two. In other words, Country A has an absolute advantage in making both food and clothing.

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· Absolute Advantage: Country A has an absolute advantage in making both food and clothing, but a comparative advantage only in food.

· Comparative advantage refers to the ability of a party to produce a particular good or service at a lower opportunity cost than another. Even if one country has an absolute advantage in producing all goods, different countries could still have different comparative advantages. If one country has a comparative advantage over another, both parties can benefit from trading because each party will receive a good at a price that is lower than its own opportunity cost of producing that good. Comparative advantage drives countries to specialize in the production of the goods for which they have the lowest opportunity cost, which leads to increased productivity.

· For example, consider again Country A and Country B in. The opportunity cost of producing 1 unit of clothing is 2 units of food in Country A, but only 0.5 units of food in Country B. Since the opportunity cost of producing clothing is lower in Country B than in Country A, Country B has a comparative advantage in clothing.

· Thus, even though Country A has an absolute advantage in both food and clothes, it will specialize in food while Country B specializes clothing. The countries will then trade, and each will gain.

· Absolute advantage is important, but comparative advantage is what determines what a country will specialize in.

2) PPC curve is outward bowed or concave to origin due to 'Law of increasing opportunity cost'. The      Marginal rate of transformation (MRT) i.e. rate of production of one commodity 'Y' is forgone to produce additional unit of other commodity 'X' is positive because of increasing opportunity cost with each unit of Y forgone.