Monday, 5 December 2011

Absolute and Comparative Advantage (Macroeconomics)

Today we come to the theories of comparative advantage and absolute advantage. Lets start with 'text-book' definitions:

  • Absolute advantage - A country is said to have an absolute advantage over another country when it can produce a good at a lower cost (using less resources).
  • Comparative advantage - A country is said to have a comparative advantage over another country with regard to a product which it can produce at a lower opportunity cost expressed in terms of alternative goods forgone. 

An example now. Take two countries, country A and B and lets look at their production of apples and televisions (crazy examples, but hey ho!). When both countries use 50% of their resources producing each good, country A can produce 5 apples and 15 televisions and Country B can produce 3 apples and 12 televisions. The opportunity cost of country A producing bananas in terms of televisions is 3. For every banana they are giving up the chance to produced 3 televisions. For Country B the opportunity cost is 4. The opportunity cost of country A producing televisions in terms of bananas  is 1/3 and the opportunity cost for country B is 1/4. 

Looking at these figures, Country A has the lowest opportunity cost for producing bananas, therefore they have the comparative advantage in producing bananas, leaving country B to produce television.  

Simple eh? Nope, it's a difficult concept to get your head around, but that is the basics. Thanks for reading and sorry about the delay. 

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