In a society of two people, trade can always make both lives better off, even if one of them is better at everything.
This is because although one can have absolute advantage in everything, one can never have comparative advantage in everything. Absolute advantage means that one can produce with less inputs than another. Comparative advantage refers to one can produce with less opportunity cost than another.
If there are two products and within an hour A can produce x units of X and y units of Y, then the opportunity cost of each unit of X in terms of Y is y/x and the opportunity cost of each unit of Y in terms of X is x/y.
Obviously, the opportunity cost of X × the opportunity cost of Y = 1.
It is the same with B.
Therefore, when one has an comparative advantage in producing one thing, he cannot has it in productiong the other.
If everyone specialize in activities in which they have a comparative advantage, then the opportunity cost of the society will be the lowest. Thus as the pie becomes larger, everyone can be better off if they buy things at a price lower than their opportunity cost and sell thing at a price higher than their opportunity cost.
This is because although one can have absolute advantage in everything, one can never have comparative advantage in everything. Absolute advantage means that one can produce with less inputs than another. Comparative advantage refers to one can produce with less opportunity cost than another.
If there are two products and within an hour A can produce x units of X and y units of Y, then the opportunity cost of each unit of X in terms of Y is y/x and the opportunity cost of each unit of Y in terms of X is x/y.
Obviously, the opportunity cost of X × the opportunity cost of Y = 1.
It is the same with B.
Therefore, when one has an comparative advantage in producing one thing, he cannot has it in productiong the other.
If everyone specialize in activities in which they have a comparative advantage, then the opportunity cost of the society will be the lowest. Thus as the pie becomes larger, everyone can be better off if they buy things at a price lower than their opportunity cost and sell thing at a price higher than their opportunity cost.
- Each person consumes goods and services produced by many other people both in the United States and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.
- There are two ways to compare the ability of two people in producing a good. The person who can produce the good with the smaller quantity of inputs is said have an absolute advantage in producing the good. The person who has the smaller opportunity cost of producing the good is said to have a comparative advantage. The gains from trade are based on comparative advantage, not absolute advantage.
- Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage.
- The principle of comparative advantage applies to countries as well as to people. Economists use the principle of comparative advantage to advocate free trade among countries.
