Chapter 2: Comparative
Advantage
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1
Learning Objectives: Understand
1. The Principle of Comparative Advantage
2. The Principle of Increasing Opportunity Cost
(also called the Low-Hanging-Fruit Principle)
3. Factors that shift the menu of production
possibilities
4. The role of comparative advantage in
international trade
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2
Do It Yourself?
 Joe Jamail, a highly successful Lebanese-American
trial attorney, employs another attorney to write
his will
 Writing
your own will
 Opportunity cost of 2 hours
 Hiring someone to spend 4 hours
on your will
 Making the right economic choice
2 hours
$10,000+
$3,200
Priceless
 Do It Yourself only when
Opportunity cost < hired cost
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3
Production Advantages: Previous Example
From the previous example:
 Jamail
has an absolute advantage at preparing
his will

Because he can perform that task than another
lawyer
 Other
lawyer has a comparative advantage
at preparing the will

Because his opportunity cost of performing that task
is lower than Jamail’s
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Production Advantages
 Definitions
 Absolute


advantage
Lowest production cost
one person has an absolute advantage over another if he or
she takes fewer hours to perform a task than the other
person
 Comparative


advantage
Lower opportunity cost than someone else
one person has a comparative advantage over another if his
or her opportunity cost of performing a task is lower than
the other person’s opportunity cost
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The Principle of Comparative Advantage
The Principle of Comparative Advantage
Everyone does best when each concentrates
on the activity with the lowest opportunity cost
Opens doors for specialization  have you ever met
an engineer who is also a medical doctor? Or a
mechanic who is also a professor?  defines the basis
for trade among people and countries
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6
Comparative Advantage Example
Production Times
Web Update
Bike Repair
Ayden
20 minutes
10 minutes
Ghadah
30 minutes
30 minutes
Ayden and Ghadah can each update web pages
and repair bikes but Ayden has an absolute
advantage in both

Because it takes Ayden less time to perform each task
• In an 8 hour day, we can translate this into quantities
Production Output
Web Update
Bike Repair
Ayden
24
48
Ghadah
16
16
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Comparative Advantage Example
Production Output
Web Update
Bike Repair
Ayden
24
48
Ghadah
16
16
Opportunity Cost
Ayden
Ghadah
Web Update
2 repairs
1 repair
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Bike Repair
0.5 update
1 update
8
Comparative Advantage Example
Production Times
Ayden
Ghadah
Hourly Output
Ayden
Ghadah
Web Update
Bike Repair
20 minutes
30 minutes
10 minutes
30 minutes
Web Update
3 updates
2 updates
Bike Repair
6 repairs
2 repairs
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Comparative Advantage Example
Hourly Output
Web Update
Bike Repair
Ayden
3 updates
6 repairs
Ghadah
2 updates
2 repairs
 Assume that 16 web updates are ordered



Ayden spends half his time at each activity: 12 updates and
24 repairs
Ghadah produces the remaining 4 updates and spends the
last 6 hours of the day making 12 repairs
Total output 16 updates and 36 repairs
 If specialization occurs then:16 updates and 48 repairs

12 more repairs for the same inputs!
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Another Example
Hourly Output
Web Update
Bike Repair
Rasha
2 updates
1 repair
Amr
3 updates
3 repairs
This table shows output per hour
 Principle
of Comparative Advantage is the
same

Look at opportunity cost per unit
Opportunity Cost
Web Update
Bike Repair
Rasha
½ repair
2 updates
Amr
1 repair
1 update
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The Principle of Comparative Advantage
Two parties have different opportunity
costs for two activities
 Concentrate
on the activities of your lowest
opportunity cost
Identify the task with which the person or country
has a comparative advantage in
Total value of output increases with specialization


• By specializing on producing tasks with which a person or a
country has a comparative advantage, the opportunity for trade
exists
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Sources of Comparative Advantage
Where does comparative advantage come
from?
 At

the individual level
Talent
• Education, training and experience
 At


the national level
Natural resources
Cultures or societal norms
• Languages
• Institutions
- Value placed on craftsmanship
- Support for entrepreneurship
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13
Moroccan Track & Field
 What has happened to Moroccan Track and Field?
 Moroccan athletes won gold medals in the following
Olympics games:
 1984: 2 gold medals
 1988: 1 gold medal
 1992: 1 gold medal
 2004: 2 gold medals
 Ethiopians specialized in 10,000-meter competition,
thus showing unsurpassed domination.
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Pearl Diving in the Gulf
 What happened to pearl diving in the Arabian Gulf?
 Pearls from the Gulf are known to be the finest in
the world.
 Arabian Gulf had comparative advantage in pearl
diving due to arid climate which made sea-related
activities the only economically-viable options.
 Global economic depression of 1930s reduced
global demand for pearls, coinciding with the
introduction of Japanese cultured pearls.
 Cultured pearls were mass produced according to
specific shape, size, and quality, thereby reducing
costs and virtually destroying the natural pearl
industry.
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Production Possibilities Curve (PPC)
 Unattainable
point
 Attainable point


Inefficient point
Efficient point
Coffee (kg/day)
 A graph of the combinations of two goods
that can be produced with given level of
resources
24 A
Unattainable
 Definitions
Combination
16
8
 Scarcity Principle
 Give
up one good to get
another
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B
Inefficient
Combination
C
D
4
8
12
Nuts (kg/day)
16
Fatima’s Production Possibilities
Two goods: coffee and
nuts
6 hours per day
 Has nimble fingers 
better for picking coffee
1 hour of labor
Coffee (kg/day)
 Work
24
16
= 4 kg of coffee OR
= 2 kg of nuts
 Graph

shows options
8
A
B
C
D
4
8
12
Nuts (kg/day)
Negative slope
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Fatima’s Opportunity Cost
 Moving from C to A:
 Marginal cost: – 8 nut
 Marginal benefit: 16 coffee
Loss in nuts
Gain in coffee
• Opportunity cost of 1 coffee is
½ nut
24
Coffee (kg/day)
 Moving from A to B:
 Marginal cost : – 8 coffee
 Marginal benefit: 4 nuts
Loss in coffee
Gain in nuts
• Opportunity cost of 1 nut is
2 coffee
A
B
16
C
8
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8
D
12
Nuts (kg/day)
18
PPC and Opportunity Cost
Hints:
 Since
Fatima’s PPC is a straight line, its slope is
constant
 The absolute value of the slope of Fatima’s PPC is the
ratio of its vertical intercept to its horizontal
intercept:


(24 kg of coffee/day)/(12 kg of nuts/day) = (2 kg of
coffee)/(1 kg of nuts)  This ratio means that Fatima’s
opportunity cost of an additional kg of nuts is 2 kg of coffee
To say that Fatima’s opportunity cost of an additional kg of
nuts is 2 kg of coffee is thus equivalent to saying that her
opportunity cost of a kg of coffee is ½ kg of nuts.
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Kamal 's Production Possibilities
Work 6 hours per day
 Productivity determines the slope of the PPC
 1 hour of labor
= 4 kg of nuts OR
A
12
= 2 kg of coffee
 Opportunity cost
8
 Marginal cost: – 4 coffee
 Marginal benefit: 8 nuts
4
 Tom's opportunity cost of
1 coffee is 2 nuts
 His opportunity cost of
1 nut is ½ coffee
Coffee (kg/day)

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B
C
D
8
16
24
Nuts (kg/day)
20
Kamal meets Fatima
24
Coffee (kg/day)
 PPCs show comparative
advantage
 Fatima's curve is steeper,
better for coffee
 Kamal's curve is flatter,
better for nuts
 Comparative advantage is a
comparison
 To get 1 coffee
 Fatima gives up ½ nuts
 Kamal gives up 2 nuts
Fatima’s PPC
12
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Kamal’s PPC
12
Nuts (kg/day)
24
21
Gains from Specialization and Trade
Without trade, each person can consume
along his production possibilities curve
 What
you produce determines what you
consume
With trade, each person's consumption can
be greater than production
 Produce
according to comparative advantage
 Trade to get what you want
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Gains from Specialization and Trade
Coffee (kg/day)
24
Fatima and Kamal
exchange
12 nuts, 12 coffee
12
8
8 12
Nuts (kg/day)
24
 Preferred diet is half nuts,
half coffee
 No trade: 8 kg of coffee
and 8 kg of nuts
 Total output is 32
pounds
 Specialization gives each
person 12 kg of each
good
 48 total kg
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Gains from Specialization and Trade
Fatima's PPC
Coffee (kg/day)
24
Trade
benefits
With trade
12
Kamal's PPC
4
No trade
4
12
Nuts (kg/day)
24
 Benefits increase when
differences in opportunity
cost increase
 Fatima's opportunity cost of
nuts increase to 6 coffee
 Kamal's opportunity cost of
coffee increases to 6 nuts
 No trade: 3.4 nuts and
3.4 coffee each
 With trade: 12 nuts and
12 coffee each
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24
Production Possibilities for an Economy
Coffee (1000s of kg/day)
 Two goods: coffee and nuts
 Multiple people
 Different opportunity costs
100
95
90
A
B
 Intercepts show maximum
production of one good
 Some resources better at coffe,
some better at nuts
C
D
E
20
15
20
30
Nuts (1000s of kg/day)
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80
77
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The Principle of Increasing Opportunity Cost
Coffee (1000s of kg/day)
 Maximum coffee: 100,000 kg / day
 Give up 5,000 kg coffee, get 20,000 kg of nuts (A  B)
 Give up another 5,000 kg of coffee, get an 10,000 additional kg of
nuts (B C)
100
95
90
A
B
C
D
E
20
15
20
30
Nuts (1000s of kg/day)
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75
80
77
26
Start with resources
with lowest
opportunity cost
Then move to next
highest opportunity
cost
And still higher
opportunity cost
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Decreasing productivity
The Principle of Increasing Opportunity Cost
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The Principle of Increasing Opportunity Cost
 PPC is bow-shaped because of increasing opportunity cost
 Also known as the “low-hanging-fruit principle”
 1st: It is easier to pick the low-hanging-fruit

2nd: if the fruit picker does not want to pick the
whole tree then it is still a better choice since the
high-hanging-fruit are more difficult to get to

3rd: if the fruit picker wants to pick the whole tree
then it is still a better choice since he can enjoy some
fast revenue from the sales of the easy to pick
sooner
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The Dynamic Economy
What shifts the PPC?
A

PPC represents current choices
Changes in choices occur over time due to
• More resources
- Investment in capital
- Population growth
• Improvements in technology
- More specialization: start-up and switching costs
• Increases in knowledge
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Shifts in PPC
Neutral Technical
Change
Coffee
Technical Change
in Coffee
Coffee
Nuts
Nuts
Coffee
Technical Change
in Nuts
Nuts
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Some Countries Resist Specialization
Specialization is easier when
 Population
density passes a threshold
 Markets are connected


Transportation for goods
Communications for services
 Legal
framework supports business
 Financial markets enable start-ups
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Too Much Specialization?
Imagine this:
 Your
hair stylist only cuts blonde hair
 A professor for each chapter!
 Seven bookstores, each open a different day of
the week
 A grocery store for every type of food
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Comparative Advantage and International
Trade
Principle of Comparative Advantage and
gains from trade apply worldwide
 Potentially
large gains from trading with
different and distant countries
Controversial trade
 Benefits
the society broadly
 Costs are concentrated


Some industries
People who lose their jobs
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Chapter 2