If the Opportunity Cost of 1 Ton of Beef Is 1 Ton of Vegetables in the United States

Learning Objectives

• Summate absolute and comparative reward

Production Possibilities and Comparative Advantage

Consider the example of merchandise in two appurtenances, shoes and refrigerators, between the United States and Mexico. These goods are homogeneous, meaning that consumers and producers cannot differentiate between shoes from United mexican states and shoes from the U.S.; nor can they differentiate between Mexican or American refrigerators.

From Table 1, we can see that it takes four U.S. workers to produce 1,000 pairs of shoes, simply it takes v Mexican workers to do so. It takes one U.S. worker to produce 1,000 refrigerators, only it takes four Mexican workers to exercise then. The United States has an accented advantage in producing both shoes and refrigerators; that is, it takes fewer workers in the United states than in Mexico to produce both a given number of shoes and a given number of refrigerators.

Table 1. Resources Needed to Produce Shoes and Refrigerators

Land	Number of Workers needed to produce ane,000 units — Shoes	Number of Workers needed to produce ane,000 units — Refrigerators
U.s.	4 workers	one worker
United mexican states	5 workers	4 workers

Absolute advantage simply compares theproductivity of a worker between countries. Information technology answers the question, "How many inputs do I need to produce shoes in Mexico?" Comparative advantage asks this same question slightly differently. Instead of comparing how many workers it takes to produce a good, information technology asks, "How much am I giving up to produce this expert in this land?" Another manner of looking at this is that comparative advantage identifies the good for which the producer'south absolute reward is relatively larger, or where the producer's absolute productivity disadvantage is relatively smaller. The United States can produce ane,000 shoes with four-fifths every bit many workers as Mexico (four versus 5), but it tin produce 1,000 refrigerators with only one-quarter as many workers (one versus iv). So, the comparative advantage of the United States, where its accented productivity reward is relatively greatest, lies with refrigerators, and Mexico's comparative advantage, where its accented productivity disadvantage is least, is in the product of shoes.

Mutually Beneficial Trade with Comparative Advantage

When nations increment production in their area of comparative advantage and trade with each other, both countries tin benefit. The production possibilities frontier is a useful tool to visualize this benefit. Recall from earlier readings that the product possibilities borderland shows the maximum corporeality that each country can produce given its express resource, in this case workers.

Consider a situation where the The states and United mexican states each have xl workers. For example, as Table two shows, if the United States divides its labor and then that 40 workers are making shoes, so, since it takes four workers in the United States to make i,000 shoes, a full of 10,000 shoes will be produced. (If four workers can make 1,000 shoes, then 40 workers will make 10,000 shoes). If the 40 workers in the U.s. are making refrigerators, and each worker can produce 1,000 refrigerators, then a total of 40,000 refrigerators will exist produced.

Table 2. Production Possibilities before Trade

Land	Shoe Product — using 40 workers		Refrigerator Production — using 40 workers
United states of america	10,000 shoes	or	40,000 refrigerators
Mexico	8,000 shoes	or	x,000 refrigerators

As always, the slope of the production possibility borderland for each land is the opportunity toll of one refrigerator in terms of foregone shoe product–when labor is transferred from producing the latter to producing the former (see Figure 1).

Figure i. Production Possibility Frontiers. (a) With 40 workers, the United States can produce either 10,000 shoes and nothing refrigerators or xl,000 refrigerators and null shoes. (b) With 40 workers, Mexico tin produce a maximum of 8,000 shoes and null refrigerators, or 10,000 refrigerators and goose egg shoes. All other points on the production possibility line are possible combinations of the 2 goods that tin be produced given electric current resources. Point A on both graphs is where the countries starting time producing and consuming before trade. Point B is where they end upwards after trade.

Let's say that, in the situation before trade, each nation prefers to produce a combination of shoes and refrigerators that is shown at point A. Table 3 shows the output of each expert for each land and the total output for the two countries.

Table 3. Production at Point A before Trade

Country	Current Shoe Production	Current Refrigerator Production
Us	v,000	xx,000
Mexico	4,000	five,000
Full	9,000	25,000

Continuing with this scenario, each country transfers some amount of labor toward its area of comparative advantage. For example, the United States transfers half dozen workers abroad from shoes and toward producing refrigerators. As a result, U.South. production of shoes decreases by i,500 units (6/4 × 1,000), while its production of refrigerators increases past six,000 (that is, half dozen/1 × 1,000). Mexico too moves production toward its area of comparative advantage, transferring 10 workers away from refrigerators and toward production of shoes. As a upshot, production of refrigerators in United mexican states falls by ii,500 (10/4 × 1,000), merely production of shoes increases by 2,000 pairs (ten/v × 1,000). Notice that when both countries shift production toward each of their comparative advantages (what they are relatively better at), their combined product of both goods rises, as shown in Tabular array 4. The reduction of shoe production by i,500 pairs in the United States is more than offset by the gain of 2,000 pairs of shoes in Mexico, while the reduction of 2,500 refrigerators in Mexico is more than offset past the boosted 6,000 refrigerators produced in the United States.

Tabular array 4. Shifting Production Toward Comparative Reward Raises Total Output

Country	Shoe Production	Refrigerator Product
United states	iii,500	26,000
Mexico	six,000	2,500
Total	9,500	28,500

This numerical instance illustrates the remarkable insight of comparative reward: even when i land has an absolute reward in all goods and another country has an absolute disadvantage in all appurtenances, both countries can still benefit from trade. Even though the United States has an accented advantage in producing both refrigerators and shoes, it makes economic sense for it to specialize in the skillful for which information technology has a comparative advantage. The United states will export refrigerators and in return import shoes.

Can a production possibility frontier exist straight?

When you first met the production possibility frontier (PPF) in an before module, it was drawn with an outward-bending shape. This shape illustrated that every bit inputs were transferred from producing 1 good to another—like from education to health services—at that place were increasing opportunity costs. In the examples in this module, the PPFs are drawn as straight lines, which means that opportunity costs are constant. When a marginal unit of measurement of labor is transferred away from growing corn and toward producing oil, the pass up in the quantity of corn and the increase in the quantity of oil is ever the aforementioned. In reality this is possible just if the contribution of additional workers to output did not change as the scale of production inverse. The linear production possibilities frontier is a less realistic model, only a straight line simplifies calculations. It also illustrates economic themes similar absolute and comparative advantage but equally clearly.

How Opportunity Cost Sets the Boundaries of Trade

This example shows that both parties can benefit from specializing in their comparative advantages and trading. By using the opportunity costs in this example, information technology is possible to identify the range of possible trades that would benefit each country.

Mexico started out, before specialization and merchandise, producing four,000 pairs of shoes and 5,000 refrigerators. Then, in the numerical example given, Mexico shifted production toward its comparative advantage and produced vi,000 pairs of shoes just only 2,500 refrigerators. Thus, if United mexican states tin canconsign no more than 2,000 pairs of shoes (giving upward 2,000 pairs of shoes) in exchange for imports of at least 2,500 refrigerators (a gain of ii,500 refrigerators), it will be able to consume more of both appurtenances than earlier merchandise. United mexican states volition exist unambiguously better off. Conversely, the United States started off, before specialization and trade, producing 5,000 pairs of shoes and 20,000 refrigerators. In the example, it so shifted production toward its comparative advantage, producing only three,500 shoes simply 26,000 refrigerators. If the United states can consign no more than than 6,000 refrigerators in exchange for imports of at least 1,500 pairs of shoes, information technology volition be able to consume more of both goods and will be unambiguously better off.

The range of trades that can benefit both nations is shown in Table 5. For case, a trade where the U.S. exports 4,000 refrigerators to Mexico in exchange for 1,800 pairs of shoes would benefit both sides, in the sense that both countries would exist able to consume more of both appurtenances than in a world without trade.

Table 5. The Range of Trades That Benefit Both the Usa and Mexico

The U.S. economic system, subsequently specialization, will do good if it:	The Mexican economic system, after specialization, will do good if it:
Exports fewer than vi,000 refrigerators	Imports at least 2,500 refrigerators
Imports at least one,500 pairs of shoes	Exports no more than ii,000 pairs of shoes

Merchandise allows each country to take reward of lower opportunity costs in the other country. If Mexico wants to produce more refrigerators without trade, it must face up its domestic opportunity costs and reduce shoe production. If Mexico, instead, produces more than shoes and and so trades for refrigerators made in the U.s., where theopportunity cost of producing refrigerators is lower, United mexican states tin in result take reward of the lower opportunity cost of refrigerators in the United States. Conversely, when the United States specializes in its comparative advantage of refrigerator production and trades for shoes produced in Mexico, international merchandise allows the United states to take advantage of the lower opportunity cost of shoe production in United mexican states.

The theory of comparative reward explains why countries trade: they take different comparative advantages. It shows that the gains from international trade result from pursuing comparative reward and producing at a lower opportunity cost. The following characteristic shows how to calculate accented and comparative advantage and the way to utilise them to a country's production.

Calculating Absolute and Comparative Reward

In Canada a worker tin can produce twenty barrels of oil or forty tons of lumber. In Venezuela, a worker tin produce 60 barrels of oil or xxx tons of lumber.

Table half dozen. Oil and Lumber Production in Canada and Venezuela
Country	Oil (barrels)		Lumber (tons)
Canada	twenty	or	40
Venezuela	sixty	or	thirty

1. Who has the absolute advantage in the production of oil or lumber? How can y'all tell?
2. Which state has a comparative advantage in the production of oil?
3. Which country has a comparative advantage in producing lumber?
4. In this example, is accented advantage the same as comparative advantage, or not?
5. In what product should Canada specialize? In what product should Venezuela specialize?

Step 1. Make a table similar Tabular array 6.

Step ii. To summate absolute advantage, look at the larger of the numbers for each product. One worker in Canada can produce more lumber (40 tons versus thirty tons), and then Canada has the absolute reward in lumber. One worker in Venezuela tin can produce 60 barrels of oil compared to a worker in Canada who tin produce only twenty.

Step 3. To summate comparative advantage, find the opportunity toll of producing 1 barrel of oil in both countries. The country with the everyman opportunity price has the comparative advantage.

With the same labor fourth dimension, Canada can produce either 20 barrels of oil or 40 tons of lumber. So in event, 20 barrels of oil is equivalent to 40 tons of lumber: 20 oil = xl lumber. Split both sides of the equation by 20 to calculate the opportunity toll of i barrel of oil in Canada. 20/20 oil = xl/20 lumber. 1 oil = 2 lumber. To produce 1 additional barrel of oil in Canada has an opportunity toll of 2 lumber.

Calculate the same way for Venezuela: 60 oil = xxx lumber. Divide both sides of the equation by 60. 1 oil in Venezuela has an opportunity cost of 1/2 lumber. Because 1/2 lumber < two lumber, Venezuela has the comparative reward in producing oil.

Step iv. Calculate the opportunity toll of one lumber past reversing the numbers, with lumber on the left side of the equation. In Canada, 40 lumber is equivalent in labor time to 20 barrels of oil: 40 lumber = 20 oil. Divide each side of the equation past twoscore. The opportunity cost of ane lumber is 1/2 oil.

In Venezuela, the equivalent labor time will produce 30 lumber or sixty oil: thirty lumber = 60 oil. Carve up each side past 30. One lumber has an opportunity price of ii oil. Canada has the lower opportunity cost in producing lumber.

Step 5. In this example, absolute reward is the same as comparative advantage. Canada has the accented and comparative advantage in lumber; Venezuela has the accented and comparative reward in oil.

Pace half dozen. Canada should specialize in what it has a relative lower opportunity price, which is lumber, and Venezuela should specialize in oil. Canada will be exporting lumber and importing oil, and Venezuela will be exporting oil and importing lumber.

Try It

Trade and Incomes

Incomes depend on labor productivity. A country with an absolute advantage in some product has higher labor productivity than another country does in the production of that product.If a country has an accented advantage in producing both appurtenances, it has college labor productivity in both and its workers will earn higher incomes than those in the other country. Thus, the average income in a country depends on its boilerplate labor productivity. Now consider comparative advantage. If a country specializes production in the product in which it has a comparative advantage, it raises its average labor productivity and raises its average income. Thus, comparative advantage is more of import than absolute advantage in agreement which country should trade which product in gild to maximize the standard of living in both countries.

Lookout man Information technology

Watch this video to review the ways that comparative reward benefits all the parties involved.

For boosted practice and review using numbers, scout this video from ACDC economics.

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Source: https://courses.lumenlearning.com/wm-microeconomics/chapter/comparative-advantage-and-the-gains-from-trade/

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