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:

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...

...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...

...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.

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...

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

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...

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

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.