Mr. Weiss Comparative Advantage Problem The theory of comparative advantage is essentially the idea that even though one entity may be better at producing a good than a second entity, it still may be beneficial to trade with the second entity if they have lower opportunity costs. Comparative advantage is most easily explained with an example. Production Possibilities Country A Country B Wheat20050 TV's10050

Mr. Weiss Comparative Advantage Problem Clearly Country A has an absolute advantage in the production of both wheat and TV's. In the given time frame Country A can produce four times as much wheat or twice as many TV's. Production Possibilities Country A Country B Wheat20050 TV's10050

Mr. Weiss Comparative Advantage Problem TV is 2 wheat for country A. Country B only has to give up 1 wheat to produce an additional TV, so the opportunity cost of 1 TV is 1 wheat for country B. Hence Country B can produce TV's cheaper (in terms of wheat) than country A. Alternatively we could also say that Country A can produce wheat cheaper (in terms of TV's) than Country B. This means that Country B should specialize in producing TV's while Country A should specialize in producing wheat. This can also be seen by graphing the production possibility frontiers for the two countries and comparing slopes. Production Possibilities Country A Country B Wheat20050 TV's10050 Now we must look at the opportunity costs. Country A must give up 2 wheat to produce each additional TV, so the opportunity cost of 1

Mr. Weiss Comparative Advantage Problem Production Possibilities Country A Country B Wheat20050 TV's10050

Mr. Weiss Comparative Advantage Problem and Country A should produce the remaining TV's and then produce wheat the rest of the time, yielding 25 TV's and 150 wheat. The total between them is now 150 wheat and 75 TV's, which is obviously better than their outcome before trade. Country B is willing to trade 1 wheat or more for each TV it produces and Country A is willing to trade 2 wheats or less for each of Country B's TV's. They will settle at a price between 1 and 2 wheat for each TV. They can each get the same amount of TV's as before and also have some extra wheat. That is an efficient move-- everyone is better off and no one is worse off. Production Possibilities Country A Country B Wheat20050 TV's10050 If the two countries still want 75 TVs between them but are now willing to trade, then Country B should only produce TVs, which would yield 50,

Mr. Weiss Comparative Advantage Problem

Mr. Weiss Comparative Advantage Problem