A Give an example of comparative advantage B What is the opp

A. Give an example of comparative advantage.

B. What is the opportunity cost of increasing capital goods this period and how does production of capital goods affect next period\'s ppc?

Solution

Comparative advantage was first described by David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal.

Comparative advantage occurs when one country can produce a good or service at a lower opportunity cost than another. This means a country can produce a good relatively cheaper than other countries

The theory of comparative advantage states that if countries specialise in producing goods where they have a lower opportunity cost – then there will be an increase in economic welfare.

For example, USa can produce either 100 units of capital goods or 50 units of consumer goods. However, India can produce either 20 units of capital goods or 40 units of consumer goods. In this case, USA has an absolute advantage over the production of both goods. But USA has comparative advantage in the production of capital goods because 100 is 5 times of 20 and 50 is 1.25 times of 40. Therefore, USA should produce capital goods and India should produce consumer goods.

b) If we produce more of capital goods today, we need to sacrifice the production of capital goods. But in next period, economiy will shift to a higher level fo PPC and more of both capital and cnsumer goods will be produced.