📊 Comparative Advantage Calculations
Key principle: A country has a comparative advantage.
Calculating opportunity cost
Given two countries and two goods with linear PPCs, the opportunity cost is calculated from the PPC endpoints:
Worked example: Country A can produce 100 cars OR 200 phones. Country B can produce 60 cars OR 300 phones. \n Opportunity cost of 1 car: \n A: 200/100 = 2 phones. B: 300/60 = 5 phones. \n → A has comp. advantage in cars (lower OC: 2 < 5). \n Opportunity cost of 1 phone: \n A: 100/200 = 0.5 cars. B: 60/300 = 0.2 cars. \n → B has comp. advantage in phones (lower OC: 0.2 < 0.5).
Each country always has a comparative advantage in exactly one good (unless OCs are identical). The opportunity costs are reciprocals — if 1 car costs 2 phones, then 1 phone costs 0.5 cars.
🤝 Terms of Trade and Gains
Terms of trade (ToT): For both countries to benefit from trade, the terms of trade (exchange ratio) must lie between the two countries' opportunity costs. \n From the example: 1 car trades for between 2 and 5 phones.
- If 1 car = 3 phones: A gains (gives up only 3 phones instead of making 2 at home... wait, A gives up 2 phones to make a car, so exporting a car for 3 phones is a gain of 1 phone).
- B gains too: B would need to give up 5 phones to make a car domestically, but only gives up 3 phones via trade — saving 2 phones.
- The closer the ToT to a country's own OC, the less it gains. The further from its own OC, the more it gains.
Why both benefit
Each country specialises in the good where it has a comparative advantage and trades for the other. Total world output of both goods increases. Both countries can consume beyond their own PPC — this is shown by the trading possibility curve.
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📈 The Trading Possibility Curve (TPC)
What is the TPC?: The trading possibility curve shows all the combinations of goods a country can consume after specialisation and trade. It lies outside the PPC — proving that trade allows consumption beyond domestic production capacity.
- The TPC starts at the country's specialisation point (all output of the comparative advantage good).
- Its slope reflects the terms of trade (not the domestic opportunity cost).
- The TPC is a straight line (linear ToT).
- The area between the PPC and TPC represents the gains from trade — combinations now accessible that were previously impossible.
Drawing the TPC for Country A: A specialises in cars → produces 100 cars. \n ToT: 1 car = 3 phones. \n If A trades all 100 cars → gets 300 phones (but has 0 cars). \n If A keeps all 100 cars → has 0 phones. \n TPC: straight line from (100 cars, 0 phones) to (0 cars, 300 phones). \n Compare to PPC: (100, 0) to (0, 200). The TPC lies OUTSIDE the PPC for phones!
The IB exam may ask you to draw or identify the TPC. Key: it shares ONE endpoint with the PPC (the specialisation point) and the other endpoint is further out, determined by the terms of trade.