Transcript Trade – A2 Economics

Absolute and
Comparative
Advantage
A2 Economics
Aims and Objectives
Aim:
• Understand the theory of absolute and
comparative advantage.
Objectives:
• Define the theory of absolute and
comparative advantage.
• Analyse the effects of specialisation
• Evaluate the case for free trade
Starter
• What is the UK current account?
• Do we have a deficit on the CA? Have we
always had a deficit on the CA?
• Is the UK trade deficit important?
Absolute Advantage
China &
Russia
Absolute Advantage
•
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Two countries
Produce just two commodities – guns and oil.
Each country has 10 units of resources
Using all resources they can produce the output shown:
Oil
Guns
China
Russia
400
320
or
or
400
160
Absolute Advantage
400
300
200
100
0
• Trading (Production) possibility diagram:
• China has an absolute advantage in
the production of both guns and
oil.
• Absolute Advantage: where a
country using a given resource
input is able to produce more than
other countries with the same
input.
100
200
300
400
Self Sufficiency
• If each country was self-sufficient and did not trade (closed
economy) the output would be shown as follows:
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280
Comparative Advantage
China &
Russia
Comparative Advantage
• While Russia has an absolute disadvantage compared to
China, it still benefits countries to specialise in the
production of a good or service.
• Theoretical basis for free trade is comparative advantage.
• Comparative Advantage: where a country can produce a
good with a lower input cost than other countries. Therefore
global resources can be allocated more efficiently.
Comparative Advantage
• Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Oil Barrel = 0.5 Gun
1 Gun = 1 Oil Barrel
1 Gun = 2 Oil Barrel
These op.cost ratios show Russia has a comparative adv. in oil, as to
produce an extra unit of oil it only has to give up half a gun compared to
1 gun for China.
Comparative Advantage
• Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Oil Barrel = 0.5 Gun
1 Gun = 1 Oil Barrel
1 Gun = 2 Oil Barrels
However, China has a comparative advantage in guns as to produce an
extra gun it only has to give up 1 unit of oil, compared to 2 units for
Russia.
Comparative Advantage
Differences in comparative adv. and op. cost give rise to international trade, where
countries specialise in the area where they have the greatest comparative adv.
Oil
Guns
China
Russia
Total Output
0
320
320
400
0
400
SPECIALISATION
However, the output of oil has
fallen from 360 to 320. Partial
specialisation can be used to
rectify this…..
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280
China
Russia
Total Output
0
320
320
400
0
400
Oil
Guns
Comparative Advantage
Original Economies Output
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280
Partially Specialised Economies Output
China
Russia
Total Output
Oil
60
320
380
Guns
340
0
340
Therefore, total output of oil has increased from 360
to 380 whilst the production of guns has also
increased from 280 to 340. International trade has
led to an increase in total supply of both products
and economic welfare will increase in both countries.
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280
China
Russia
Total Output
Oil
60
320
380
Guns
340
0
340
Plenary
Define and give examples of comparative and
absolute advantage.
Should specific countries specialise in the sole
production of just a few goods, for which they
possess a comparative advantage?