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Absolute vs. Comparative Advantage

Before digging into comparative advantage, it's important to first understand specialization, and how that determines what goods a society produces.

Specialization explained

The Isle of Crammer Nation and the Archipelago of Economicals are known for their incredible caffeinated drinks. While both societies utilize the same resources (a.k.a. capital) to make their energy drinks and coffee, they each have their respective production secrets to producing each good.

The Archipelago of Economicals is known to have one of the most efficient and effective production techniques for creating energy drinks, while the Isle of Crammer Nation has spent more time crafting their coffee production capabilities.

We can conceptualize this as...

Specialization is the limiting of ones work to a particular area, typically the area in which is it most beneficial to produce.

Given the same resources, see the below table for each society's production capabilities:

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

As we can see, the Isle of Crammer Nation is better at producing coffee and the Archipelago of Economicals is better at producing energy drinks. This would result in the two trading with one-another so each respective society doesn't need to waste time producing the good that they're specialized in.

Specialization and trade generates gains for societies. It enables societies to focus on what they're good at, and not waste resources on goods or services that other societies can do more efficiently.

Identifying absolute advantage

To identify who has the absolute advantage for what product, imagine that no trade was occurring. All it comes down to is who can produce more units of a given product with the same resources.

Let’s take a look at our current table and see which country can make the most of each product.

For coffee...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

...it is clear that the Isle of Crammer Nation has the absolute advantage because they can make 100 units whereas the Archipelago of Economicals can only make 50.

For energy drinks...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

...it is clear that the Archipelago of Economicals has the absolute advantage because they can make 200 units whereas the Isle of Crammer Nation can only make 100.

In summary:

To determine who has absolute advantage, ask yourself: Who can outright make more of the good opposed to the other producer?

Now that we've understood absolute advantage, let's dig into the inner-workings of comparative advantage!

Identifying comparative advantage

To find the comparative advantage for producing coffee vs. energy drinks for Isle of Crammer Nation & Archipelago of Economicals, we must first calculate the per-unit opportunity cost for each production option.

Let's start with determining the opportunity cost of coffee for the Isle of Crammer Nation.

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation100???100???
Archipelago of Economicals50???200???

We must ask ourselves...

How many coffees does Isle of Crammer Nation have to sacrifice to produce one energy drink?

Here's the best trick for easily answering this:

When calculating opportunity cost of a good, the OTHER good goes OVER.

So, in the case of the above question, we're asking for the opportunity cost of coffee.

Opportunity cost of 1 coffee = ??? / ???

Therefore, the "OTHER" good is energy drinks. That means that energy drinks is going to go "OVER" coffee.

Opportunity cost of 1 coffee = ___ energy drinks / ___ coffees

Now, all we need to do is plug in Isle of Crammer Nation's Energy Drink value...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

...and its Coffee value...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

...and its Coffee value...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

Opportunity cost of 1 coffee = 100 energy drinks / 100 coffees

...to determine that the opportunity cost of producing 1 coffee for the Isle of Crammer Nation is 1 energy drink!

Opportunity cost of 1 coffee = 100 / 100 = 1 energy drink

Let's take note of that in our table, with "C" representing "Coffee" and "E" representing "Energy Drink".

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E100???
Archipelago of Economicals50???200???

If we were to repeat the same process for Archipelago of Economicals, it'd result in the following equation...

Opportunity cost of 1 coffee = 200 energy drinks / 50 coffees

...meaning that the opportunity cost of 1 coffee for them equals to 4 energy drinks!

Opportunity cost of 1 coffee = 200 / 50 = 4 energy drinks

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E100???
Archipelago of Economicals501 C = 4 E200???

Energy Drink

Let's repeat the same process for energy drinks...

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E100???
Archipelago of Economicals501 C = 4 E200???

...starting with the opportunity cost of 1 energy drink for Isle of Crammer Nation.

Opportunity cost of 1 energy drink = ??? / ???

In this case the OTHER is coffee, so that will go OVER energy drinks.

Opportunity cost of 1 energy drink = ___ coffees / ___ energy drinks

Let's plug in the values from the table...

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

Opportunity cost of 1 energy drink = 100 coffees / 100 energy drinks

...to result in an opportunity cost equal to 1 coffee!

Opportunity cost of 1 energy drink = 100 / 100 = 1 coffee

Let's go ahead and plug that into our table!

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E200???

If we were to repeat the same process for Archipelago of Economicals, it'd result in the following equation...

Opportunity cost of 1 energy drink = 50 coffees / 200 energy drinks

...meaning that the opportunity cost of 1 coffee for them equals to 1/4 (or 0.25) energy drinks!

Opportunity cost of 1 energy drink = 50 / 200 = 1/4 energy drinks

Let's go ahead and plug that into our table!

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E2001 E = 1/4 C

So... who has the comparative advantage?

In essence...

Comparative advantage answers the question of WHO should specialize in WHAT.

Remember, we want to look down our columns and see which country gives up less to produce 1 unit of each product, this will indicate who has the comparative advantage in that product. 

Coffee

To start, who sacrifices less to produce 1 coffee?

Isle of Cramer Nation only needs to sacrifice 1 energy drink (E) to produce 1 coffee...

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E2001 E = 1/4 C

...whereas Archipelago of Economicals needs to sacrifice 4 energy drinks (E)!

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E2001 E = 1/4 C

Therefore, the Isle of Crammer Nation has the comparative advantage in the production of coffee (C). 

To determine who has comparative advantage, ask yourself: Who can make the good at a lower opportunity cost than the opposing producer?

Energy Drink

On the flip side, who sacrifices less to produce 1 energy drink?

Isle of Cramer Nation sacrifices 1 coffee (C) to produce 1 energy drink...

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E2001 E = 1/4 C

...whereas the Archipelago of Economicals only sacrifices 1/4 coffee (C).

CoffeeOpp. CostEnergy DrinkOpp. Cost
Isle of Crammer Nation1001 C = 1 E1001 E = 1 C
Archipelago of Economicals501 C = 4 E2001 E = 1/4 C

Therefore, the Archipelago of Economicals has the comparative advantage in the production of energy drinks (E).

Graphing trade specialization

Specialization and trade can also be graphed on a productions possibilities frontier.

Simply make the y-axis one product (Coffee) and the x-axis the other (Energy Drink). The two curves will represent our different countries and will hit each axis at their respective production amounts. 

The lines for Isle of Crammer Nation and Archipelago of Economicals hit on the y-axis (Coffee)...

...at their maximum production points represented in the table.

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200

Likewise, the lines for Isle of Crammer Nation and Archipelago of Economicals hit on the x-axis (Energy Drink)...

...at their maximum production points represented in the table.

CoffeeEnergy Drink
Isle of Crammer Nation100100
Archipelago of Economicals50200