Comparative Advantage

Topics: Economics, Comparative advantage, International trade Pages: 3 (753 words) Published: October 4, 2013
MBA 525 ~ Practice with comparative advantage and gains from trade.

The principle of comparative advantage states that if nations (or individuals) specialize in the production of goods and services that they can produce at lower opportunity cost relative to other nations, then there can be mutual gains from trade. As a result, there will be more efficient production and consumption. Applying the efficiency principle, this means that mutually beneficial trade allows each nation to consume a mix of goods that is beyond what they could produce alone – the whole pie is bigger, so everyone can have a larger slice.

Example to see gains from trade:

Assume that Jay and Leah can spend the day either washing cars or mowing lawns. The table below shows how much of each task they could accomplish in one day if they spent the whole day doing just that task. For example, Jay could wash 20 cars or mow 5 lawns in one day. ______________________________________________

Jay Leah
______________________________________________
Cars washed 20 15
Lawns mowed 5 3
______________________________________________

Note: Jay has the absolute advantage in both goods. This does not mean that he has comparative advantage. Even though he is “better” at producing both goods than Leah, he can still benefit from trading with her.

Question: Use the principle of comparative advantage to illustrate how specialization can make them more productive than they can be alone.

Steps:

1. Calculate the opportunity cost of each activity for each person.

Jay
The opportunity cost of mowing 5 lawns is washing 20 cars.
 the opportunity cost of mowing 1 lawn is washing 4 cars.  the opportunity cost of washing 1 car is mowing ¼ of a lawn.

Leah
The opportunity cost of mowing 3 lawns is washing 15 cars.
 the opportunity cost of mowing 1 lawn is washing 5 cars.  the opportunity cost of washing 1 car is mowing...
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