Saturday, April 26, 2014

Comparative Advantage

Danny wrote:

Hi professor, 
For example, given two countries and two outputs such as trains and planes, when determining which has the comparative advantage, do you compare within the country itself or between countries? That is, should you be comparing whether producing one particular good has a lower opportunity cost than the other in that same country? Or comparing whether producing one particular good has a lower opportunity cost in another country relative to your own country? 
In other words, are the comparisons of opportunity costs performed horizontally or vertically? I am confused. 
For an example, please see: At 2:00mins, the instructor suggests comparing between countries, however, isn't comparative advantage and opportunity costs compared within the same country? Or is it because the introduction of trade changes it around? Not really sure. 
Thanks for any help

My response:

The question that might help you to understand this is this.  Suppose trade between the two countries can occur and is costless.  Then an efficient production plan that produced a given amount of trains would maximize the number of airplanes produced.  How should production be divided across the two countries to attain an efficient production plan? 
If the efficient production plan entails one country specializing in production, for example say that country A produces Trains only while country B produces Trains and Planes, with the result an efficient plan, then we say that country A has a comparative advantage in producing Trains.   
Further, if you considered a different efficient production plan with a bit less production of Trains and a bit more production of planes, then the way to get from the first to the second is by having country B reduce its production of trains and increase its production of planes and have country A continue to specialize in the production of trains.  

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