Comparative advantage - output approach | Basic economic concepts | Microeconomics | Khan Academy

In this, in the next video, we're going to learn how to calculate opportunity costs and determine who has the comparative advantage in a goods production using data from both an output table and an input table. If we look at our PPCs in the graph on the left, we see the potential outputs of two goods: shoes and basketballs for two different countries: Country A in blue and Country B in green. Notice that the data on this PPC is also represented in the table on the right. Country A can produce up to six pairs of shoes per worker or up to eight basketballs per worker. Contrast that with Country B, which can produce up to four pairs of shoes or four basketballs with a single worker.

Notice that in this table, the variable, the data that appears in the table, is the output. This is the potential output of the two goods that the country can produce with a fixed amount of inputs. Each worker, in other words, workers are input. Each worker can produce the numbers of basketballs and shoes indicated in the table.

To calculate the opportunity costs of shoes and basketballs in these two countries, we can use the following method. We know that for every six pairs of shoes, all right, 6s, Country A produces, it gives up eight basketballs. The resources needed to produce six shoes could also produce eight basketballs. To find the opportunity cost of shoes, all I have to do is divide both sides of this equation by six, and I can see that the opportunity cost of one pair of shoes is eight sixths or four thirds of a basketball.

Now, I like to convert these fractions to decimals because it's easier to compare decimals against one another than it is to compare fractions, which may possibly have different denominators. So I'm going to go ahead and convert this four thirds to a decimal, and that gives me an opportunity cost of 1.33 basketballs per pair of shoes produced in Country A.

Let's now calculate the opportunity cost of basketballs in terms of shoes. Country A can produce either eight basketballs or six shoes. To find the cost of basketballs, I just divide both sides by eight here, and I get an opportunity cost of three-fourths of a pair of shoes per basketball. Again, I'm going to convert this to a decimal to make it easier to compare opportunity costs across countries. Three-fourths of a shoe comes out to 0.75 pairs of shoes per basketball.

I now have my opportunity costs of shoes and basketballs for Country A. It's gonna be a lot quicker to calculate these opportunity costs for Country B because Country B can produce either four pairs of shoes or four basketballs, giving the country an opportunity cost of shoes of one basketball per pair of shoes. Likewise, for basketballs, with the resources it takes to produce four basketballs, the country could have produced four pairs of shoes. Divide both sides by four and I get a cost of basketballs of one pair of shoes per basketball.

Now I have all the information I need to determine who has the comparative advantage in these two goods, and with that information, I know how the countries can specialize and trade with one another in a way that benefits both countries mutually. Let's first look at shoes. We can see that Country A can produce shoes at the opportunity cost of 1.33 basketballs per shoe, and Country B can produce shoes at the opportunity cost of one basketball per pair of shoes. Clearly, Country B can produce shoes at the lower opportunity cost, so Country B should specialize in shoe production since that's what it has a comparative advantage in.

For basketballs, Country A can produce basketballs at an opportunity cost of 0.75 pairs of shoes per basketball, whereas Country B must give up one pair of shoes per basketball, giving Country A the comparative advantage due to its lower opportunity cost in basketball production.

So with this information, we can come up with some conclusions. First, we know that Country A should specialize in basketball production because it can produce basketballs at a lower opportunity cost than Country B. Next, we know that Country B should specialize in shoe production due to its lower opportunity cost of one basketball per pair of shoes compared to 1.33 basketballs per pair of shoes in Country A.

Let's go back over to our PPC on which will indicate the points at which both countries A and B will produce based on the principle of comparative advantage. Country A is going to produce nothing but basketballs due to its lower opportunity cost, putting Country A down here on its production possibilities curve. Country B will then produce nothing but shoes due to its lower opportunity cost, putting Country B at this point on its production possibilities curve.

Now, you may be wondering how does Country B get basketballs if it's not producing any domestically, and how does Country A get shoes if it's not produced in any domestically? Of course, the answer to that lies in trade. By trading with one another, both countries will be able to consume some combination of basketballs and shoes that is beyond each country's domestic production possibilities.

So these dashed lines that I'm drawing now represent what we could call the trading possibilities curves of both countries A and B. Through specialization and trade, a country can consume at a point beyond what would be possible if it were to produce everything for itself without trading with other countries. The two dots here that I'll label X and Y represent possible levels of consumption which lie beyond what the country would have been able to achieve if they had chosen to try to produce both shoes and basketballs for themselves.

In the next video, we're going to look at a different type of situation in which we're given not the number of outputs that a country can produce, rather the amount of inputs needed to produce a single unit of two different goods.