Comparative Advantage and Trade

Vocabulary• Trade: dividing tasks • Gains From Trade: By dividing tasks the people

involved can each get more of what they want.• Gains from trade arise, in particular, from the division

of tasks, economics call this specialization: different people both engage in different tasks.

• Comparative advantage: The production cost is lower for the individual than for others.

• Absolute Advantage: producing more output with a given amount of input.

Comparative Advantage and Gain from Trade

• Say Tom is stranded on a deserted island, and Hank, another castaway, just so happens to wash a shore. Could they both benefit from trading with each other?

• Its an obvious scenario if both Tom and Hank have different skills that each can feed off of. Each man can use his skill to trade the benefit of their skills with one another.

• Saying that Tom can catch fish and Hank can climb trees, it would make sense for Tom to catch fish, Hank to gather coconuts and for them to trade their goods with one another = specialization.

Continued

• There are gains in economics from trading with a party that has a skill/good not as useful.

• Say that Hank is not as adaptable to the primitive life, Tom who’s better at catching fish and surviving, none the less they both can benefit from the skills each other have and are better off with each other than without.

Tom Related to Productivity

Tom’s consumption without trade.

Quantity of coconuts

Quantity of fish

0

9

30

4028

Toms’ PPC

Hank Related to Productivity

Hank’s consumption without trade

Quantity of fish

Quantity of coconuts

0

20

8

6 10Hank’s PPC

Opportunity Cost

Tom’s Opportunity Cost Hank’s Opportunity Cost

One Fish ¾ coconut 2 coconuts

One coconut 4/3 fish ½ fish

How They Gain

Without trade With trade Gains from trade

FishTom: Coconuts

Production: Consumption: 28 28 9 9

Production: Consumption: 40 30 0 10

+2 +1

FishHank: Coconuts

6 6 8 8

0 10 20 10

+4 +2