We’ve now seen that, despite Bruce having an absolute advantage in both making sales and making coffees, it still made sense for Dick to specialise more in coffees and for Bruce to specialise more in sales. This is because…
This is because Dick had a comparative advantage making coffee, the opportunity cost for him to make coffee is lower, he’d be giving up fewer sales than Bruce.
But how do Dick and Bruce specialising in coffee and sales relate to entire countries specialising in different goods?
To answer that, we need to think back to PPFs…
PPF stands for production possibility frontier, and a production possibility frontier shows the maximum output combinations of two goods.
Let’s imagine that Uzbekistan and Germany can both only produce two goods: cashmere and…frankfurters. Here is their PPF:
Which country has an absolute advantage in producing each of the products?
Germany has an absolute advantage in the production of both frankfurters and cashmere, because it can produce more of both.
But who has a comparative advantage in the production of frankfurters? And who has a comparative advantage in the production of cashmere?
Let’s start by identifying who has a comparative advantage in producing frankfurters.
To work out who has a comparative advantage in producing frankfurters, we first need to calculate both countries’ opportunity costs for producing frankfurters.
To calculate an opportunity cost using a PPF, we can just look at the intercepts – the points where the lines meet the axes.
If Germany produce 500 million frankfurters, how many kgs of cashmere will they have to give up making?
If Germany produce 500 million frankfurters, they’ll have to give up making all 400 million kilograms of cashmere they could’ve made instead.
So, the opportunity cost of making 500 million frankfurters is 400m kg of cashmere
So, what’s the opportunity cost of making 1 frankfurter?
To find the opportunity cost of making 1 frankfurter we need to divide our 500,000,000 frankfurters by 500,000,000 to get down to 1 frankfurter.
Which means we also need to divide by 500m on the other side, so we get 0.8 on the right hand side. And that means that, for every 1 frankfurter Germany makes, they’ll have to give up making 0.8 kg of cashmere!
So, what is Uzbekistan’s opportunity cost of producing 1 frankfurter?
First we need to look at the intercepts and spot that the opportunity cost of producing 20 million frankfurters is 200,000,000 kilograms of cashmere.
To find the opportunity cost of making 1 frankfurter we need to divide our 20,000,000 frankfurters by 20,000,000 to get down to 1 frankfurter.
That means we also need to divide by 200m on the other side, so we get 10 on the right hand side. And that means that, for every 1 frankfurter Uzbekistan makes, they’ll have to give up making 10 kg of cashmere!
So whereas Germany had to give up only 0.8kg of cashmere, Uzbekistan had to give up 10kg! Meaning Germany has a lower opportunity cost for producing frankfurters than Uzbekistan does!
In other words, Germany is giving up less cashmere by producing more frankfurters.
If a country can produce a good at a lower opportunity cost, what kind of advantage do they have?
If a country can produce a good with a lower opportunity cost, that country has a comparative advantage; Germany is giving up less cashmere to produce frankfurters, and so it has a comparative advantage in producing frankfurters.
So, Germany doesn’t just have an absolute advantage in the production of frankfurters, it also has a comparative advantage – it can also make frankfurters at a lower opportunity cost.
But all is not lost for Uzbekistan – let’s now work out who has a comparative advantage in the production of cashmere.
To work out who has a comparative advantage in the production of cashmere, we need to calculate the opportunity costs for both countries’ producing cashmere.
First, we look at the intercepts.
If Germany produce 400 million kgs of cashmere, how many frankfurters will they have to give up making?
