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Comparative and Absolute Advantage

Absolute Advantage

Let’s consider this scenario.

One worker in Florida can produce 50 oranges.
One worker in North Dakota can produce 2 oranges.

Absolute advantage means that someone can produce more of a good. This is equivalent to saying they requires fewer resources to produce it.

Comparative Advantage

One worker in Florida can produce 50 oranges or 30 turnips.
One worker in North Dakota can produce 15 oranges or 10 turnips.

Which one should the worker in North Dakota produce?

Be careful

The North Dakotan can produce more oranges. However, for every orange they produce, they lose out on 2/3 = 0.6666 of a turnip. For every orange a Floridian produces, they lose out on on 0.6 turnips. Therefore, Floridians lose less by producing oranges.

Another way of thinking about it: ratios

Floridians can produce 3.333 times the number of oranges, but only 3 times the number of turnips. In order to maximize their advantage, they should produce oranges.

Example with Bill Gates

Mark Zuckerberg is a genius. He is a better programmer than most and a much better businessman than most. Why doesn’t he program? Think of it like this. He’s 5 times better at programming than the average software engineer. However, he’s 20 times better at business than the average businessman. Therefore, to maximize his profit, he does more business rather than programming.

What is comparative advantage?

Someone has a comparative advantage if they can produce something with less opportunity cost.

Terms of Trade

One worker in Florida can produce 50 oranges or 30 turnips.
One worker in North Dakota can produce 15 oranges or 10 turnips.

As we talked about earlier, Florida would produce oranges, and North Dakota would produce turnips. What would the exchange be for the two goods? First, we have to realize, that 1 turnip must be greater than 1.5 oranges. Otherwise, North Dakota would just produce their own oranges. Similarly, Florida can produce 1.66 oranges for every turnip, so they would want to buy it for less.

Therefore, the terms of trade is 1 turnip is between 1.5 and 1.66 oranges.

Automatic Stabilizers

Price Elasticity of Demand