An individual, a firm, a region, or a county may develop an area of specialization naturally, but frequently choices must be made to determine what to produce for exchange or trade. Producers should concentrate on the activity in which the)- have an absolute advantage. An absolute advantage is the ability to product a good or service using fewer resources than other producers use. In the United States, this situation occurs when one region of a country is more suited than another for producing certain pro¬ducts.
Florida can grow oranges using fewer resources than Iowa, where heated green¬houses would be necessary. Iowa has vast, flat acreage and can produce corn much more efficiently than could Florida. Thus, Florida specializes in oranges while Iowa concentrates on com. and the products are exchanged through the marketplace. When each of two parties has an absolute advantage over the other in producing a particular good or service, it is easy for both to decide their areas of specialization. But what happens when one party’ can produce both goods and services more effi¬ciently than a second party?
Should the party with the absolute advantage produce both products for itself? Although this party has the advantage in producing cither good, it should specialize in producing the good in which it has a comparative advantage. Comparative advantage is the ability to produce a good or service at a lower opportunity cost than other producers facc. 1’his means lerting the other party produce the good in which it has the lower opportunity cost. Total output will be greater, and exchange will allow both parties to have both goods. Suppose a woman can make $100 per hour as a marketing consultant.
Part of her work includes preparing reports for her clients. Suppose that in addition to being a first-class consultant, she is more efficient at word processing than anyone she might hire to key the reports. Thus, she might be able to key in one hour what it takes an assistant two hours to do. As a result, she reasons that, instead of hiring an assistant to do the work, she should do it herself. Is she right to do her own keying as well as consulting? If she docs her own keying, she still must take an hour each day from her consulting to do so.
The opportunity cost of keying is the S100 she could have earned consulting. The opportunity cost of consulting is the S20 she must pay an assistant to key the reports. Therefore, if she hires an assistant, she can devote her hill time or consulting. I led gross earnings will be $ 100 greater per day. After paying the assistant $20 for two hours work, she will still have additional net income of $80 per day. Thus, the marketing consultant is bcucr-off specializing full time in the service for which she has the greater comparative advantage.
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Topic: Absolute and Comparative Advantage
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