Comparative Advantage - Consuming Above PPF

• Comparative advantage

  A country has the lowest opportunity cost for producing a good or service
• Specialization and trade

  1. Country specializes in producing good/service with lowest opportunity cost

  2. Countries trade with each other at a suitable exchange rate
• Specialization and trade


  Allows countries to consume beyond their own production possibility curve (PPC)
• Production possibility curve (PPC)


  • Represents the maximum combination of goods/services a country can produce with its resources
• Jack and Jill

  • Two countries that can produce forks or knives
• Opportunity cost


  The amount of one good/service that must be given up to produce one more unit of another good/service
• Determining comparative advantage

  1. Calculate opportunity cost of producing forks vs knives for each country

  2. Country with lower opportunity cost has comparative advantage
• Jack has comparative advantage in knife production, Jill has comparative advantage in fork production
• Suitable exchange rate


  Rate at which countries can trade their goods/services, e.g. 1 fork = 1 knife
• Specialization and trade at suitable exchange rate


  Allows countries to consume beyond their own PPC
• The new consumption point attainable through specialization and trade lies beyond the original PPCs of the two countries
• Specialization and trade based on comparative advantage leads to a large welfare gain for both countries