Comparative advantage worked example

- [Instructor] The countries of Kalos and Johto can produce two goods. Shiny charms and berries. Yep, you got to love these worlds created in these economics questions. The table below describe the production possibilities of each country in a day. So here it tells us that Kalos, if it puts all of its energy behind charms, it can produce 10 charms in a day. But if it put all of its energy behind berries, it can produce 20 berries in a day. And then Johto, all of its energy behind charms, 25, all of its energy behind berries, 75. Given these numbers are based on both countries having the same labor and capital inputs, who has the absolute advantage in charms? So pause the video and see if you can figure this out. All right, so let's just remind ourselves. Absolute advantage is just who is more efficient? Who, given the same inputs, can produce more? And they told us that these countries, they have the same labor and capital inputs, so this is really just a question of who can produce more charms in a day? And you can see very clearly that Johto can produce more charms in a day. And so I would say Johto, because they produce, let me write that a little bit neater, they produce more charms per day. Charms per day. With same inputs. Same inputs. So they are more efficient. More efficient. So they have the absolute advantage. Now this is an interesting thing, because our intuition might say well whoever has the absolute advantage, maybe they're the ones that should be producing charms. But this is what's interesting when we study comparative advantage. That is not always the case. And I suspect that this question will lead us there. All right, next question. They say calculate the opportunity cost in Kalos of charms. So the opportunity cost, in Kalos, of charms. So when Kalos decides to produce 10 charms, they're trading off 20 berries. Or another way of thinking about it, it costs them 20 berries to produce 10 charms. So we could say it costs 20 berries for 10 charms, which is equal to two berries, two berries per charm, in Kalos. So there you have it. The opportunity cost, they trade off two berries per charm. And actually, let me make it a little column here. The opportunity cost. So this is two berries per charm. And I have a feeling, and if you're taking an exam, say an AP exam, it's not a bad idea to just fill this thing out, so what is the opportunity cost, they haven't asked us that yet, but I'm just gonna do it really fast. What is the opportunity cost of charms in Johto? Well, they are trading off, to produce 25 charms, they trade off 75 berries. So this would be 75 divided by 25, this would be three berries per charm. 75 berries for 25 charms is three berries per charm. And if you want to know the opportunity cost of berries, well you can just take the reciprocal of each of these. So in Kalos, the opportunity cost is one half charms, charms per berry. And then in Johto, it is one third charms per berry. That if they wanted to produce 25 berries, if they wanted to produce 75 berries, they would trade off 25 charms. So it would cost them 25 charms to produce 75 berries, or one third of a charm per berry. So I'm just doing a little bit of extra. But then it's gonna be useful, because in the next question, they actually are asking us, who, we'll scroll up a little bit. They're saying who has the comparative advantage in berries, explain. So berries, whoever has the lower opportunity cost has the comparative advantage. So we see here that Johto has the lower opportunity cost in berries. One third is lower than one half. It's a lower opportunity cost of producing a berry. So Johto has one third charms per berry opportunity cost, opportunity cost. Which is lower than Kalos', Kalos' one half charms per berry opportunity cost. So Johto has comparative advantage. So Johto has comparative, comparative advantage in berries. And I apologize a little bit for my penmanship, I'm trying to save time by writing a little bit fast, but hopefully me saying it out loud at the same time is making it somewhat legible. All right. So the next question. If these countries were to specialize in trade, who would produce which good, explain. Well whoever have the comparative advantage of each will produce that one. So Kalos has comparative advantage, Kalos has lower opportunity cost in, in let's see, they have the lower opportunity cost when you compare them to, oh let me see, let me put it this way. For charms, let me write I this way, Kalos has a lower opportunity cost for charms. Kalos has advantage in charms. And then we already said Johto has advantage in berries. And so, Kalos, I keep saying it weird, Kalos produces charms, Johto produces berries, produces berries. And once again, this goes back to something we touched on at the beginning of the video. Even though Johto has the absolute advantage, in fact they have the absolute advantage in either, Johto is not, even though they can produce charms way more efficiently than Kalos, Johto is actually in this, if you buy all the arguments of comparative advantages, Johto should actually produce the berries, while Kalos should produce the charms, because they have a lower opportunity cost in terms of berries. Now let's answer this last question right over here. What would be a trading price that Johto and Kalos would agree on to trade charms for? Now you might be saying, well what's a price, I'm used to saying that in terms of just maybe dollars or some type of currency, how do I answer a price right over here? Well, the key is that we can give a price in terms of opportunity cost. So they want a price of charms. So it really could be in terms of berries. So let's see. Let's look at each of their cost of charms. So, Kalos' opportunity costs of a charm is two berries per charm, Johto's in three berries per charm. So let me rewrite that over here. So Kalos, Kalos opportunity cost of charms is two berries per charm. And then Johto opportunity cost of charms is three berries per charm. And here we're going to appreciate why comparative advantage works. We said that Kalos would be the one that would focus on the charms. And so notice. If they can sell the charms to Johto for something that is higher than their opportunity cost, and lower than Johto's opportunity cost, then they both benefit. And so a good price, let's say you could go halfway between the two, but it really could be anything in between the two, let's say 2.5 berries per charm. They both benefit. So they would trade at this, trade at 2.5 berries per charm. Why does this make sense for Johto, even though they have the absolute advantage? Well if they produce nothing but charms, it would cost them, or no matter what they do, it'll cost them three berries per charm. But now they figured out a way, through trade, to get charms at two and a half berries per charm. And so this will be a better deal for Johto. And so one thing to appreciate when we talk about comparative advantage, some people think that it's about one country benefiting more than the other. But if we assume all of the assumptions about comparative advantage in our models, then it's actually about both countries that are trading benefit. They will both be better off. They will both get gains from trade, and both will be better off.