ECON1101 Study Guide - Final Guide: Comparative Advantage, Absolute Advantage, Opportunity Cost
International Trade
Comparative Advantage
• Country A has a comparative advantage over country B in the production of a good if the
opportunity cost of producing the good in country A is less than in country B.
• Eg: AUS more efficient than FOR in producing both beef and textiles.
• AUS has an absolute advantage in both.
• In beef, FOR takes 2x as long (60 hrs/30hrs).
• In textiles, FOR takes 1.6x as long (8/5 = 1.6).
• Since opportunity cost of beef is 6 units of textiles in AUS but 7.5 units
in FOR, there exist gains from trade:
o AUS trades beef for FOR textiles.
o FOR trades textiles for AUS beef.
• Ad eah epads hat it a produe or osue eportig the good it has a
comparative advantage in.
• Gains from trade – eah epads hat it a produe or osue by exporting the good it
has the comparative advantage in.
Wage Costs and Trade
• Competition guarantees goods produced wherever it is cheapest.
1. A high productivity country can compete and pay higher wages.
2. Wage differences only limited by labour productivity differences.
• Equilibrium relative wages 1.6 w/wf 2 → AUS is LCP of beef and FOR is LCP of textiles.
• Given equilibrium relative wages, there are 3 possible cases:
I. Case X: if w/wf = 1.6 (no lowest-cost producer for textiles)
→ AUS produces both goods and is LCP of beef, FOR
produces only textiles.
II. Case Y: if w/wf = 2 (no LCP for beef) → AUS produces only
beef, FOR produces both goods and is LCP of textiles.
III. Case Z: if 1.6 < w/wf < 2 → Both countries specialise: AUS
(LCP of beef) produces only beef, FOR (LCP of textiles)
produces only textiles.
• In each case: AUS produces and exports beef (comparative adv.)
and imports textiles, and FOR produces and exports textiles (comparative adv.) and imports
beef.
Reasons for Comparative Advantage
1. Climate – impact on agricultural production and tourism services.
2. Natural resources – oil from OPEC countries, gold mining in AUS not Japan.
3. Technology/Knowledge/Human Capital – eg: growth of AUS wine production and exports.
4. Capital-Labour Ratios:
o Capital abundant US and Europe produce Boeing and Airbus planes (capital intensive
production).
o Labour abundant China produce toys and clothing (labour intensive production).
• Dynamic comparative advantage – comparative advantage changes over time due to
investment in physical and human capital and in technology.
Economic Arguments for International Trade
1. Voluntary exchange is mutually advantageous.
2. Comparative advantage and specialisation.
3. Exploit economies of scale.
4. Benefits of increased competition.
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Document Summary
In beef, for takes 2x as long (60 hrs/30hrs). Case x: if w/wf = 1. 6 (no lowest-cost producer for textiles) Aus produces both goods and is lcp of beef, for produces only textiles. Case y: if w/wf = 2 (no lcp for beef) aus produces only beef, for produces both goods and is lcp of textiles. Case z: if 1. 6 < w/wf < 2 both countries specialise: aus (lcp of beef) produces only beef, for (lcp of textiles) produces only textiles. In each case: aus produces and exports beef (comparative adv. ) and imports textiles, and for produces and exports textiles (comparative adv. ) and imports beef. Economic arguments for international trade: voluntary exchange is mutually advantageous, comparative advantage and specialisation, exploit economies of scale, benefits of increased competition. Intra-industry trade: occurs when countries both import and export goods in the same industry, eg: sweden .
