absolute and comparative advantage a2 economics. aims and objectives aim: understand the theory of...
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Absolute and Comparative AdvantageA2 Economics
Aims and Objectives
Aim: • Understand the theory of absolute
and comparative advantage.Objectives: • Define the theory of absolute and comparative advantage.• Analyse the effects of specialisation• Evaluate the case for free trade
Starter
• What is the UK current account?
• Do we have a deficit on the CA? Have we always had a deficit on the CA?
• Is the UK trade deficit important?
Absolute Advantage
China & Russia
Absolute Advantage• Two countries• Produce just two commodities – guns and oil.• Each country has 10 units of resources• Using all resources they can produce the output
shown: China Russia
Oil 400 320
or or
Guns 400 160
Absolute Advantage• Trading (Production) possibility diagram:
0 100 200 300 400
100
200
300
400
• China has an absolute advantage in the production of both guns and oil.
• Absolute Advantage: where a country using a given resource input is able to produce more than other countries with the same input.
China
Russia
Self Sufficiency
• If each country was self-sufficient and did not trade (closed economy) the output would be shown as follows:
China Russia Total Output
Oil 200 160 360
Guns 200 80 280
Comparative Advantage
China & Russia
Comparative Advantage
• While Russia has an absolute disadvantage compared to China, it still benefits countries to specialise in the production of a good or service.
• Theoretical basis for free trade is comparative advantage.
• Comparative Advantage: where a country can produce a good with a lower input cost than other countries. Therefore global resources can be allocated more efficiently.
Comparative Advantage
• Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Gun = 1 Oil Barrel
1 Oil Barrel = 0.5 Gun
1 Gun = 2 Oil Barrel
These op.cost ratios show Russia has a comparative adv. in oil, as to produce an extra unit of oil it only has to give up half a gun compared
to 1 gun for China.
Comparative Advantage
• Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Gun = 1 Oil Barrel
1 Oil Barrel = 0.5 Gun
1 Gun = 2 Oil Barrels
However, China has a comparative advantage in guns as to produce an extra gun it only has to give up 1 unit of oil, compared to 2 units for
Russia.
Comparative Advantage
Differences in comparative adv. and op. cost give rise to international trade, where countries specialise in the area where they have the greatest comparative adv.
China Russia Total Output
Oil 0 320 320
Guns 400 0 400
SPECIALISATION
However, the output of oil has fallen from 360 to 320. Partial specialisation can be used to
rectify this…..
China Russia Total Output
Oil 0 320 320
Guns 400 0 400
China Russia Total Output
Oil 200 160 360
Guns 200 80 280
Comparative Advantage
Original Economies Output
Partially Specialised Economies Output
China Russia Total Output
Oil 60 320 380
Guns 340 0 340
China Russia Total Output
Oil 200 160 360
Guns 200 80 280
Therefore, total output of oil has increased from 360 to 380 whilst the production of guns has also
increased from 280 to 340. International trade has led to an increase in total supply of both products
and economic welfare will increase in both countries.
China Russia Total Output
Oil 200 160 360
Guns 200 80 280
China Russia Total Output
Oil 60 320 380
Guns 340 0 340
Plenary
Define and give examples of comparative and absolute advantage.
Should specific countries specialise in the sole production of just a few goods, for which they possess a comparative advantage?