Google
Saturday 
October 21, 2017 

AmosWEB means Economics with a Touch of Whimsy!

AmosWEBWEB*pediaGLOSS*aramaECON*worldCLASS*portalQUIZ*tasticPED GuideXtra CrediteTutorA*PLS
BANK RESERVES: The "money" that banks use to conduct day-to-day business, including cashing checks, satisfying customers's withdrawals, and clearing checks between accounts at different banks. The "money" in question includes vault cash and Federal Reserve deposits. Specifically, vault cash is the paper money and coins that a bank keeps on the bank premises (both in the vault and in teller drawers), which is used to "cash" checks and otherwise provide the funds that customers withdraw. Federal Reserve deposits are accounts that banks keep with the Federal Reserve System, which are used to process, in a systematic, centralized fashion, the millions of checks written each day by customers of one bank that are deposited by customers of another bank. Using these deposits, the Fed acts as a central clearing house for checks, being able to simultaneously debit the account of one bank and credit the account of another. More on the importance of bank reserves can be found under fractional-reserve banking.

Visit the GLOSS*arama


COMPARATIVE ADVANTAGE:

The ability to produce one good at a relatively lower opportunity cost than other goods, especially compared to production in another country. Every person or country has a comparative advantage in production of at least one good or service, even with relatively limited production technology. A related, but contrasting concept is absolute advantage. Both terms are perhaps most important to the study of international trade, but also provide insight into other exchanges.
A comparative advantage arises when the production of one good or service can be had at a relatively low opportunity cost, that is, foregoing a relatively small quantity of other production. Technical efficiency or advanced technology that might give rise to an absolute advantage is not the source of comparative advantage. In fact, an extremely productive person or country, one able to produce a great deal of output using few inputs will also be foregoing a great deal of production and incurring a high opportunity cost when produce something else.

While a person, country, business, government, or other producing entity may or may not have an absolute advantage in production, every producer has a comparative advantage in the production of something.

The Best and the Brightest

To illustrate comparative advantage, consider the production abilities of at Lawrence Alexander III, the best and the brightest. Lawrence has an absolute advantage over everyone in everything he does. He is smarter, a better athlete, more skilled, and more talented than anyone.

However, in spite of Lawrence's documented superiority in ALL activities, he does NOT undertake ALL activities. He can craft furniture better than anyone else, but he actually purchases his furniture from others. He is unmatched as an actor and singer, yet he is entertained by watching others perform. He was intelligent enough to pursue any field of academic study in college, including economics, but he chose only to study medicine.

If Lawrence can produce everything better than anyone, why then does he purchase anything? Why is he not totally self sufficient in his production and consumption?

Enter Opportunity Cost

The key to comparative advantage is opportunity cost, the highest valued alternative foregone in the pursuit of an activity. A person (or nation) has a comparative advantage in the production of a good if the relative opportunity cost of production is less.

The absolute superiority that Lawrence has in every activity actually works against him when it comes to comparative advantage. Because Lawrence is so incredibly productive, when he undertakes one activity, he foregoes a great deal of alternative production from another activity. The value of this foregone production is the opportunity cost that he incurs.

As a skilled surgeon, Dr. Lawrence Alexander III produces valuable life-saving medical care. Which means that foregoing surgery in pursuit another activity leads to an extremely high opportunity cost.

Suppose, for example, that Lawrence can generate $1,000 of valuable production for each hour that he spends performing operations. Now suppose that he decides to spend 8 hours building a bookcase, and in so doing, he foregoes 8 hours of surgery. While this might be an extremely well-crafted bookcase, the opportunity cost of its production is $8,000, the value of the foregone surgery. That's an incredibly expensive piece of furniture.

Lawrence is actually better off spending his time removing gall bladders and repairing knife wounds, then using the income he generates to buy a bookcase from someone else, someone else with a lower opportunity cost of production.

Someone like Becky Carpenter. Becky is an extremely talented carpenter, who can also craft fine furniture. However, unlike Lawrence Alexander III, she is not particularly skilled or talented at other productive activities, including surgery. When she builds a bookcase, she incurs a relatively low opportunity cost because she is giving up very little. She also spends 8 hours making a bookcase, but in so doing all that she gives up is a job working as a clerk at a department store that pays $10 per hour. Her opportunity cost of bookcase construction is only $80.

The relative opportunity costs facing Lawrence and Becky are what make specialization and trade possible. Lawrence can specialize in surgery and purchase furniture from Becky. Becky can specialize in furniture production, and if necessary, have Lawrence remove her ruptured appendix. The great thing about this arrangement is that each can become skilled and proficient in their particular productive effort.

The same can be said about nations.

Specialization and Trade

A Comparative Advantage
Comparative Advantage
In the same way that people like Becky Carpenter can have a comparative advantage in production, so too can nations. As the chart to the right illustrates, the United Provinces of Csonda, a technologically advanced nation, clearly has an absolute advantage over the less industrialized Republic of Northwest Queoldiola in the production of both turnips and sundials. Csonda can produce both goods using fewer resources that Northwest Queoldiola.

A month of Csondan labor can produce 60 pounds of turnips or 20 sundials, while a Queoldiolan worker can produce only 20 pounds of turnips or 10 sundials with the same amount of effort. Csonda is absolutely the best.

But, much like Lawrence, the Csondan absolute advantage actually works against it. Because Csonda can produce more, it incurs a higher opportunity cost of production when producing another good.

Consider, the opportunity cost of producing sundials.

  • If Csonda switches a unit of labor from turnip production to sundial production, it is able to produce 20 sundials and in so doing gives up 60 pounds of turnips. As such, the production of each Csondan sundial incurs an opportunity cost of 3 pounds of turnips.

  • In contrast, if Northwest Queoldiola switches a unit of labor from turnip production to sundial production, it is able to produce 10 sundials, but in so doing only gives up 20 pounds of turnips. As such, the production of each Queoldiolan sundial incurs an opportunity cost of only 2 pounds of turnips.
The cost of sundial production in Northwest Queoldiola is less than the cost in Csonda (2 pounds of turnips versus 3 pounds of turnips). Northwest Queoldiola gives up less to produce each sundial. Even though Csonda has an absolute advantage in the production of sundials, Northwest Queoldiola has a comparative advantage.

The Law of Comparative Advantage

The inclination for any nation to find a good that it can produce at a lower opportunity cost than another nation is summarized in the law of comparative advantage.

The law of comparative advantage states that every nation has a production activity that incurs a lower opportunity cost than that of another nation, which means that trade between the two nations can be beneficial to both if each specializes in the production of a good with lower relative opportunity cost.

Because Northwest Queoldiola incurs a lower opportunity cost than Csonda, it makes sense for Csonda to import sundials from Northwest Queoldiola.

<= COMPANYCOMPARATIVE STATICS =>


Recommended Citation:

COMPARATIVE ADVANTAGE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: October 21, 2017].


Check Out These Related Terms...

     | international economics | international finance | foreign trade | international trade | absolute advantage | law of comparative advantage | gains from trade |


Or For A Little Background...

     | exports | imports | net exports | foreign sector | specialization | opportunity cost | production | technical efficiency | voluntary exchange |


And For Further Study...

     | balance of trade | balance of trade surplus | balance of trade deficit | balance of payments | international market | foreign trade policies | tariffs | import quotas | export subsidies | terms of trade | foreign exchange market |


Related Websites (Will Open in New Window)...

     | World Trade Organization | General Agreement on Tariffs and Trade |


Search Again?

Back to the WEB*pedia


APLS

YELLOW CHIPPEROON
[What's This?]

Today, you are likely to spend a great deal of time lost in your local discount super center trying to buy either a how-to book on home repairs or a large, stuffed kitty cat. Be on the lookout for vindictive digital clocks with revenge on their minds.
Your Complete Scope

This isn't me! What am I?

A U.S. dime has 118 groves around its edge, one fewer than a U.S. quarter.
"I shall do less whenever I shall believe what I am doing hurts the cause and I shall do more whenever I shall believe doing more will help the cause. I shall try to correct errors when shown to be errors and I shall adopt new views so fast as they shall appear to be true views. "

-- Abraham Lincoln, 16th US president

MU
Marginal Utility
A PEDestrian's Guide
Xtra Credit
Tell us what you think about AmosWEB. Like what you see? Have suggestions for improvements? Let us know. Click the User Feedback link.

User Feedback



| AmosWEB | WEB*pedia | GLOSS*arama | ECON*world | CLASS*portal | QUIZ*tastic | PED Guide | Xtra Credit | eTutor | A*PLS |
| About Us | Terms of Use | Privacy Statement |

Thanks for visiting AmosWEB
Copyright ©2000-2017 AmosWEB*LLC
Send comments or questions to: WebMaster