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You are expected to explain/analyze (AO2) absolute and comparative advantage and the sources of comparative advantage (HL), draw (AO4) linear PPC diagrams showing comparative advantage and the potential gains between countries (HL), and calculate (AO4) the opportunity costs for goods for countries (HL).
Absolute Advantage (AO2)
Absolute Advantage (AO2)
A country has an absolute advantage when it can produce more of a good or service than another country.
For example, if you look at this table, Country A is able to produce more oil than Country B.
Country B is in turn able to produce more cheese than Country A.
However, this is not a very suitable indicator for advantage; instead, comparative advantage is used as it shows with country should specialize in what based on opportunity cost.
Comparative Advantage (AO2) (AO4)
Comparative Advantage (AO2) (AO4)
Who has comparative advantage?
A country has a comparative advantage when it can produce a given amount of a good or service at a lower opportunity cost than another country.
In other words, it needs to give up less resources to produce the same amount.
This diagram illustrates the Production Possibility Curves for Country A and Country B, and the two goods oil and cheese, using the table from above.
Before trading, both countries had to sustain themselves. In this ->
example:
Country A produces 5k oil barrels and 1.5k blocks of cheese
Country B produces 1k oil barrels and 4.5k blocks of cheese
However, this is not very efficient. Instead, how about the countries trade?
After trading, the two countries can specialize in producing one good. This is determined by finding the opportunity cost:
For each additional oil barrel produced, Country A loses 0.3 possible blocks of cheese. Country B loses 4.5 blocks. The lower opportunity cost is for Country A, hence Country A should specialize in oil production.
For each additional cheese block produced, Country A loses 3.3 possible barrels of oil. Country B loses x barrels. The lower opportunity cost is for Country B, hence Country B should specialize in cheese production.
↑ People always mess this up (by flipping it around) so take care! ↑
A way to remember it would be by drawing the diagram out and look at the angles between the curves. No real math involved either ->
Remember that this angle method is not a valid explanation in a test, and is simply meant to help you find the country with the advantage
Now, because Country A and Country B can produce 10k and 9k units of their specialized good, they could potentially trade 4k oil barrels with 3k cheese blocks.
This means Country A has 6k oil barrels and 3k blocks of cheese.
This means Country B has 4k oil barrels and 6k blocks of cheese.
Notice how both of these values are beyond their "before trading" possibilities? That is the power of comparative advantage and international trading.
Sources of comparative advantage
Some countries have more natural resources than others and are hence able to produce more at a lower opportunity cost
Some countries have a higher level of technology in one industry than others
Some countries have done more research and development
Some countries' currencies decrease in value, making exports more attractive (more about this is learned in a future chapter)
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