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Explain the Concept of Comparative and Absolute Advantage

Suppose the USA and Canada are considering to trade. Assume there are only two goods in the economy: potatoes and rice. The table below illustrates what each country can produce in a given year.

Potatoes Rice

USA 8 4

Canada 10 16

1. In this case, which country should produce potatoes? Why? Hint: calculate the opportunity cost for each country. For instance, USA can produce 8 units of potatoes OR 4 units of rice. In this case, if the USA produces one unit of rice, then it has to give up 2 units of potatoes

2. How does trade affect the production possibilities frontier?

3. Give 5 factors that can expand the production possibilities frontier.

Solution Preview

1.
USA's opportunity cost for rice = 8 units of potatoes / 4 units of rice = 2 units of potatoes per unit of rice
Canada's opportunity cost for rice = 10 units of potatoes / 16 units of rice = 0.625 units of potatoes per unit of rice

Canada's opportunity cost ...

Solution Summary

This solution uses a concrete example to illustrate the concept of Comparative and Absolute Advantage, and how that concept affects international trade and the Production Possibilities Frontier (PPF).

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