CIA4U ABSOLUTE AND COMPARATIVE ADVANTAGE

Example 1: Absolute Advantage

	Time Spent Building Furniture	Time Spent Preparing a Will	Time Saved Through Specialization
Lawyer	20 hours	2 hours	20-2=18 hours
Carpenter	5 hours	10 hours	10-5=5 hours

Specialization allows a country to produce more than what it needs and trade for other needs, using its resources more efficiently and increasing living standards.

Example 2: Comparative Advantage

	Hypothetical Output per Worker		Opportunity Cost
	Paper	Computers	Of 1 ton of paper	Of 1 computer
Canada	12 tons	12 computers	1 computer	1.0 ton of paper
Mexico	3 tons	9 computers	3 computers	0.33 tons of paper

Canada has the absolute advantage in both products. However, Canada has the comparative advantage in paper, while Mexico has it in computers. A country should produce the product it has the lowest opportunity cost in.

Specialization:

Assume Canada has 10 workers, Mexico 20 and that each devoted half its labour force to production of each product. Assume also these are each country’s minimum needs.

	Before Trade		After Specialization
	Paper	Computers	Paper	Computers
Canada	60 t	60	120 t	0
Mexico	30 t	90	0 t	180

Trade:

Terms of trade dictate the degree to which countries benefits. The minimum terms of trade must allow each country to have more product overall than before the specialization and trade.

At 1t paper = 1 computer, Canada needs 60 computers, but gives up 60t paper.

	After Specialization		After Trade
	Paper	Computers	Paper	Computers
Canada	120 t	0	60 t	60
Mexico	0 t	120	60 t	120

Mexico benefits in both products but Canada is merely back to the original production level prior to specialization. Unacceptable.

At 1t paper = 2 computers, trade 30t paper for 60 computers.

	After Specialization		After Trade
	Paper	Computers	Paper	Computers
Canada	120 t	0	90 t	60
Mexico	0 t	120	30 t	120

Canada has benefited in paper, but not in computers.

Mexico has benefited in computers, but not in paper.

But both countries now have more total product.

Given Canada had the absolute advantage in both products originally, determine a terms of trade agreement where Canada benefits in both, and Mexico at least benefits in one product.

At 3t paper = 8 computers, trade 33t paper for 88 computers.

	After Specialization		After Trade
	Paper	Computers	Paper	Computers
Canada	120 t	0	90 t	88
Mexico	0 t	120	33 t	92