AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/1/1-4)
Unit 1 · Topic 1.4
1.4 Comparative Advantage and Trade
Absolute advantage means producing more with the same resources; comparative advantage means producing at a lower opportunity cost. When each side specializes in its comparative-advantage good and trades at terms between their opportunity costs, both can consume beyond their own PPC.
Key terms
- absolute advantage
- comparative advantage
- specialization
- terms of trade
- gains from trade
Absolute vs. comparative advantage
A producer has an absolute advantage in a good if it can make more of that good with the same resources, or make the same amount using fewer resources.
A producer has a comparative advantage in a good if it can make it at a lower opportunity cost than the other producer. Comparative advantage is what decides who should specialize in what.
One producer can have an absolute advantage in both goods, but it can't have a comparative advantage in both. If you give up less of good Y to make X, you must give up more of X to make Y. (If two producers' opportunity costs are exactly equal, neither has a comparative advantage and there's nothing to gain from trade.)
Output problems vs. input problems
Questions give data in one of two forms, and the math flips between them. A memory trick for each is in the table.
| Data type | What the numbers show | Opportunity cost of 1 X | Absolute advantage goes to |
|---|---|---|---|
| Output | How much each can make with the same resources (units per day) | units of Y ÷ units of X ('other over') | the larger number |
| Input | Time or resources needed to make one unit (hours per unit) | hours for X ÷ hours for Y ('input over') | the smaller number |
Specialization and terms of trade
Specialization means each producer focuses on the good it has a comparative advantage in. Together they then produce more total output than if each made some of both.
The terms of trade are the price at which the two sides swap goods, written as units of one good per unit of the other. For trade to help both sides, the terms must fall between the two producers' opportunity costs. If one tablet costs Alba 3 shirts and costs Bryn 5 shirts, a deal of anywhere between 3 and 5 shirts per tablet helps both. At exactly 3 or 5, one side gains nothing.
With good terms, each side can consume a combination of goods outside its own PPC. That's the gain from trade. Production possibilities don't change; consumption possibilities do.
Why this matters beyond countries
The same logic applies to people and firms. A doctor might type faster than her assistant (absolute advantage in typing), but every hour she spends typing costs her an hour of seeing patients. Her opportunity cost of typing is far higher, so the assistant has the comparative advantage in typing and both gain when each specializes.
Trade can still create losers inside a country, such as workers in an industry that faces new import competition. Unit 2 shows how that plays out in a single market using surplus.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Output problem: who specializes in what
With the same resources in one day, Alba can make 30 shirts or 10 tablets, and Bryn can make 20 shirts or 4 tablets. Who has the absolute advantage in each good? Who has the comparative advantage in each? Give a range of terms of trade that benefits both.
Show the solutionHide the solution
- Step 1: Absolute advantage (output data, bigger number wins): Alba makes more of both (30 > 20 shirts, 10 > 4 tablets), so Alba has the absolute advantage in both.
- Step 2: Alba's opportunity cost of 1 tablet = 30 ÷ 10 = 3 shirts. Bryn's = 20 ÷ 4 = 5 shirts. Alba gives up less, so Alba has the comparative advantage in tablets.
- Step 3: Alba's opportunity cost of 1 shirt = 10 ÷ 30 = 1/3 tablet. Bryn's = 4 ÷ 20 = 1/5 tablet. Bryn gives up less, so Bryn has the comparative advantage in shirts.
- Step 4: Terms of trade must fall between the two opportunity costs: more than 3 and fewer than 5 shirts per tablet.
Answer: Alba: absolute advantage in both, comparative advantage in tablets. Bryn: comparative advantage in shirts. Any terms between 3 and 5 shirts per tablet help both.
- Example 2Calculator allowed
Input problem (classic trap)
Carlos needs 2 hours to make a pizza and 4 hours to make a cake. Dee needs 3 hours to make a pizza and 9 hours to make a cake. Who has the comparative advantage in cakes?
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- Step 1: These numbers are hours per unit, so this is an input problem. A smaller number means more productive, so Carlos has the absolute advantage in both goods.
- Step 2: Opportunity cost of 1 cake: the hours a cake takes could make (hours for a cake ÷ hours for a pizza) pizzas. Carlos: 4 ÷ 2 = 2 pizzas. Dee: 9 ÷ 3 = 3 pizzas.
- Step 3: Carlos gives up fewer pizzas per cake, so Carlos has the comparative advantage in cakes.
- Step 4: Check the other good: 1 pizza costs Carlos 2 ÷ 4 = 1/2 cake and Dee 3 ÷ 9 = 1/3 cake, so Dee has the comparative advantage in pizza.
- Step 5: The trap: using the 'other over' rule from output problems would give 2 ÷ 4 and 3 ÷ 9 for cakes and flip the answer.
Answer: Carlos has the comparative advantage in cakes (2 pizzas per cake vs. 3); Dee has it in pizza.
- Example 3Calculator allowed
Showing consumption outside the PPC
Using the Alba and Bryn data, Alba specializes in tablets (10) and Bryn in shirts (20). They trade 3 tablets for 12 shirts. Show that both end up outside their own PPC.
Show the solutionHide the solution
- Step 1: The terms are 12 ÷ 3 = 4 shirts per tablet, which is between 3 and 5, so both should gain.
- Step 2: Alba keeps 10 − 3 = 7 tablets and gets 12 shirts. Without trade, making 7 tablets would leave her time for only 30 − 3 × 7 = 9 shirts. 12 > 9, so she's outside her PPC.
- Step 3: Bryn keeps 20 − 12 = 8 shirts and gets 3 tablets. Without trade, making 3 tablets would leave him time for only 20 − 5 × 3 = 5 shirts. 8 > 5, so he's outside his PPC too.
Answer: Alba consumes 7 tablets and 12 shirts (her PPC allows only 9 shirts with 7 tablets); Bryn consumes 3 tablets and 8 shirts (his PPC allows only 5). Both gain.
Common mistakes
- Deciding specialization by absolute advantage. A producer that's better at everything still should specialize only where its opportunity cost is lower.
- Using the output formula on input data. With hours per unit, the opportunity cost of X is hours for X ÷ hours for Y.
- Giving terms of trade outside the range, or exactly at one producer's opportunity cost. The terms must be strictly between the two costs for both sides to gain.
- Saying trade shifts each country's PPC outward. Trade moves consumption outside the PPC; production possibilities don't change.
On the exam
- Expect a table of outputs or inputs and questions about absolute advantage, comparative advantage, opportunity cost per unit and acceptable terms of trade. Writing out the per-unit opportunity cost for each producer earns the points.
- Free-response questions may ask you to describe both producers' PPCs as straight lines, with each axis intercept equal to the most of that good the producer can make.
Connected topics
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Check yourself
4 questions on 1.4 Comparative Advantage and Trade. Pick an answer to see if you got it, and why.
| Country | Cheese (pounds per worker per day) | Bread (loaves per worker per day) |
|---|---|---|
| Alpha | 12 | 6 |
| Beta | 8 | 2 |
Hypothetical output per worker
Which of the following is true about absolute advantage?
What is Beta's opportunity cost of producing one loaf of bread?
Based on comparative advantage, which of the following describes how the two countries should specialize?
Which of the following terms of trade would benefit both countries?
0 of 4 answered