Opportunity cost and comparative advantage using an output table | AP Macroeconomics | Khan Academy

What we're going to do in this video is draw a connection between the idea of opportunity cost of producing a good in a certain country and comparative advantage between countries in a certain good. Below right over here, we have a chart that shows the production possibility curves for two different countries. As we see in many economic models, this is, I would argue, an oversimplified model, but it helps us get some insights.

In each country, workers can only produce some combination of sneakers and basketballs. To help us understand this and to appreciate that you can see this information in multiple ways, let's present this also as an output table. An output table is something you will sometimes see. From either the production possibility curves or from the output table, we can calculate the opportunity cost of shoes and the opportunity costs of basketballs, and then try to deduce some things about comparative advantage.

So, in an output table, we would look at Country A, and we would look at Country B. We would think about, “Well, what is the max?” I'll just draw it. What is the max basketballs? This is all per worker per day. We would also think, “What is the max shoes?” Those look like socks, but you get the idea, once again per worker per day. So let me draw a little chart here so we can do that.

What I'd like you to do is pause this video and see if you can fill in this chart. What is the maximum basketballs per worker per day in Country A and then Country B? Then, do the same thing for shoes.

Alright, now let's work this together. So first, in Country A, what is the maximum number of basketballs? Well, if in Country A they put all of their energy into basketballs, we are right over here on the production possibilities curve. They can produce eight basketballs. If, on the other end of the curve, they put all their energy into shoes, they would produce no basketballs and six pairs of shoes. We're assuming that these are pairs of shoes that we're talking about, six pairs of shoes.

Similarly, if we go to Country B, I keep saying company instead of country. If we go to Country B and we say, “What's the maximum number of basketballs?” Well, if they put all their energy into basketballs, we get four basketballs and no pairs of shoes. That's four basketballs. But then, if they put all the energy into pairs of shoes, they produce no basketballs. They could produce four pairs of shoes.

So it's as simple as that. This output table is just showing the extremes from the production possibility curves for these countries. Now, with the information from both the output table and these production possibility curves, let's calculate the opportunity cost. So let me set up another table and let me just say this is going to be our opportunity cost table (OC, not Orange County).

Once again, it's going to be for Country A and Country B, and we're going to think about the opportunity cost of producing basketballs. That's going to be in terms of pairs of shoes and then the opportunity costs for producing pairs of shoes, and that's going to be in terms of basketballs.

Let me set up another table. I encourage you once again to pause this video and see if you can fill in this table. What is the opportunity cost? We'll start with what's the opportunity cost for producing basketballs in terms of shoes in Country A.

Alright, well, there's a couple of ways to think about it. Imagine a world in Country A where you're producing no basketballs and you're producing six pairs of shoes. But then, if you were to increase the number of basketballs you produce by eight, so if you add eight basketballs, you're going to give up six pairs of shoes. You see that right over here? You give up six pairs of shoes.

So in Country A, eight basketballs cost six shoes. Let me write that down. So in Country A, eight basketballs—I'll just say "b" for short—cost six, six "s" (s is shoes for short). Or another way to think about it, if you divide both of these by eight, one basketball costs six over eight shoes. All I did is take eight basketballs that cost six shoes, and one basketball is going to cost six divided by eight pairs of shoes.

So what is that going to be? Well, six over eight is the same thing as three-fourths, or three-fourths of a pair of shoes. So one basketball costs three-fourths of a pair of shoes, or we could say that is 0.75 "s," where "s" is a pair of shoes for this simplified notation.

What about in Country B? Well, in Country B, if I go from no basketballs to four basketballs, then I would have given up four pairs of shoes. I would have given up four pairs of shoes. So in Country B, four basketballs cost four pairs of shoes. If you divide both by four, you could say one basketball costs one pair of shoes.

So a basketball here in Country B costs one pair of shoes. Once again, "s" is a pair of shoes. You could have also gotten it from this information here. You could set up an equation. You could say, "Look, if I put all of my energy in Country A, if I put..." So let's look at this part right over here. You could say in Country A, if I put all of my energy into basketballs, I could produce eight basketballs.

But if I put that same energy into shoes, I could produce six pairs of shoes. With the same energy, I could produce either one of these. If I want the opportunity cost for basketballs, I divide both by eight, and that's essentially what I did over here. I get that a basketball costs six-eighths of a pair of shoes or three-fourths of a pair of shoes, which is exactly what I have over here.

Now let's do the opportunity cost for a pair of shoes in either country. There are a couple of ways to think about it. You could just view it as the reciprocal, or you could even go back to this equation right over here. If we are in Country A, we would say six shoes. If we put all our energy in shoes, we could produce six of them—or six pairs of shoes, I should say.

If we put all of our energy into basketballs, we could produce eight basketballs. If you divide by six, you get per pair of shoes. The energy to produce one pair of shoes is equivalent to the energy to produce eight-sixths of a basketball. Eight-sixths is the same thing as four-thirds of a basketball.

If we wanted to write it as a decimal just for simplicity or maybe to make it easier to compare, we would say that this is approximately 1.33. Obviously, the threes just keep going on, it repeats forever. But approximately 1.33 basketballs is the cost of producing a shoe, and the opportunity cost of producing a shoe in Country A is 1.33 basketballs.

What about in Country B? Well, in Country B, we could set up a similar type of equation where the same energy for four shoes, I could produce four basketballs and that's essentially what we set up right over here on the left. You divide both sides by four. The energy of a shoe is equal to the energy of a basketball, or I should say the energy of a pair of shoes is equal to the energy of making a basketball.

So the opportunity cost of making a pair of shoes is equal to one basketball. Now we're ready to draw the connection. Given the opportunity costs that we have calculated, what country has the comparative advantage in basketballs? Pause this video and try to figure it out.

Now, let's look at the opportunity cost of producing a basketball in either country. In Country A, each basketball costs a worker three-fourths of a pair of shoes. In Country B, it costs them a whole pair of shoes. So Country A actually has a lower opportunity cost of producing basketballs, and so it has the comparative advantage here—comparative advantage.

Then, if we look at shoes, it goes the other way around. Country A has an opportunity cost of one and one-third basketballs for every pair of shoes, while Country B has an opportunity cost of only one basketball per pair of shoes, so it has a lower opportunity cost.

This one actually might be a little bit counterintuitive because if you look on the shoe axis right over here, Country A has the absolute advantage in producing shoes. A worker per day in Country A can produce six pairs of shoes, while a worker in Country B can only produce four pairs of shoes.

But even though Country A has the absolute advantage, it would actually make sense for Country A to focus on basketballs while Country B focuses on shoes. In the next video, we'll see how they can trade with each other to get to a scenario that is beyond their production possibility curves. And why focusing on your comparative advantage, at least in this theoretical, very simplified world, makes sense.