ECC1000 Study Guide - Quiz Guide: Absolute Advantage, Comparative Advantage, Opportunity Cost
6 Jun 2018
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Chapter 3: Interdependence and the Gains from Trade
Comparative Advantage: The Force of Specialisation (page 52)
• Economists use the term absolute advantage when comparing the productivity of one
person, firm, or nation to that of another.
• The producer that requires a smaller quantity of inputs to produce a good is said to have
an absolute advantage in producing that good.
Opportunity Cost and Comparative Advantage
• Economists use the term comparative advantage when describing the opportunity costs
faced by two producers.
• The producer who gives up less of other goods to produce Good X has the smaller
opportunity cost of producing Good X and is said to have a comparative advantage in
producing it.
• Although it is possible for one person to have an absolute advantage in both goods, it
is impossible for one person to have a comparative advantage in both goods.
• Because the opportunity cost of one good is the inverse of the opportunity cost of the
other, if a person’s opportunity cost of one good is relatively high, the opportunity cost
of the other good must be relatively low.
Comparative Advantage and Trade
• The gains from specialisation and trade are based on comparative advantage
• When each person specializes in producing the good for which he or she has a
comparative advantage, total production in the economy rises.
• This increase in the size of the economic pie can be used to make everyone better off.
• Trade can benefit everyone in society because it allows people to specialize in activities
in which they have a comparative advantage.
The Price of Trade
• For both parties to gain from trade, the price at which they trade must lie between the
two opportunity costs.
• Each party can buy a good at a price that is lower than his or her opportunity cost. In
the end, each person specializes in the good for which he or she has a comparative
advantage and is, as a result, better off.
