Tom and Harry lived in an island. The island is rich in Coconut and Fish. They have to gather coconut and catch fish for their food. In one hour Tom can gather 10 coconut or catch 2 fish and Harry can gather 30 coconut or catch 3 fish.
|Coconut per hour||Fish per hour|
In one day they can work for 8 hours. In one day Tom can gather 80 coconut or catch 16 fish and Harry can gather 240 coconut or catch 24 fish.
|Coconut per day||Fish per day|
Both of them decide to spend 4 hours every day on each of the food items.
Given below are their Production Possibility Frontiers
Harry boasts about his superior skills in gathering coconut and catching fish. Tom agrees with Harry and tells him that you have an absolute advantage. Harry asked what does absolute advantage means? Tom replies
The ability to produce a good using fewer inputs than another producer is called as an absolute advantage.
Tom then told that if we work together then we can get more food in the same amount of time. He told that Harry should work for 6 hours gathering coconut and 2 hours catching fish and Tom will work for 8 hours catching fish. If they work together this way then
Harry can trade 50 coconut with Tom for 7 fish. The result will be
For the same amount of time both Tom and Harry has 10 more coconut and 1 additional fish. Clearly by working together and trading they are able to gather more good in the same amount of time. Tom tells that this is called as comparative advantage.
The ability to produce a good at a lower opportunity cost than another producer is called as comparative advantage. The producer who gives up less of the other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it.
Tom can gather 10 coconut or catch 2 fish in one hour. If he choses to catch 1 fish then he had to give up gathering 5 coconut. So 5 coconut is Tom’s opportunity cost if he decides to catch 1 fish. Harry can gather 30 coconut or catch 3 fish in one hour. If Harry choses to catch 1 fish then he had to give up gathering 10 coconut. Since Tom has the least opportunity cost (5 coconut < 10 coconut) he should take up catching fish. In the same way you can compute the opportunity cost for gathering 1 coconut. From the table given below you can clearly see that Tom should catch fish and Harry should gather coconut.
|1 Fish||1 Coconut|
|Tom||5 coconut||0.2 fish|
|Harry||10 coconut||0.1 fish|
Should Tiger Woods mow his own lawn?
Tiger Woods is one of the greatest golf players. Let us imagine that he can mow his lawn faster than anyone. But just because he can mow his lawn fast, does this mean he should? The answer is Woods should not mow his lawn. From the book Principles of Economics
Let’s say that Woods can move his lawn in 2 hours. In that same 2 hours, he could film a television commercial for Nike and earn $10,000. By contrast, Forrest Gump, the boy next door, can mow Wood’s lawn in 4 hours. In that same 4 hours, he could work at McDonald’s and earn $20. In this example, Wood’s opportunity cost of mowing the lawn is $10,000 and Forrest’s opportunity cost of mowing the lawn is $20. Woods has an absolute advantage in mowing lawns because he can do this work with a lower input of time. Yet Forrest has a comparative advantage in mowing lawns because he has the lower opportunity cost.
Countries too can benefit from comparative advantage
United States and Japan are equally good in producing cars. Let us assume both the countries can produce 1 car in a month. United States has more land which enables it to produce more food than Japan. Let us assume that in one month United States produces 2 tons of food and Japan can produce 1 ton in a month. From the book Principles of Economics
The principle of comparative advantage states that each good should be produced by the country that has the smaller opportunity cost of producing that good. Because the opportunity cost of a car is 2 tons of food in United States but only 1 ton of food in Japan, Japan has a comparative advantage in producing cars. Japan should produce more cars than it wants for its own use and export some of them to the United States. Similarly, because the opportunity cost of a ton of food is 1 car in Japan but only 1/2 car in the United States, the United States has a comparative advantage in producing food. The United States should produce more food than it wants to consume and export some to Japan.
David Ricardo in his 1817 book On the Principles of Political Economy and Taxation gives an example of comparative advantage between England and Portugal.
In Portugal it is possible to produce both wine and cloth with less labor than it would take to produce the same quantities in England. However the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.
Trade allows all countries to achieve greater prosperity.