PART 1 The Scope of Economics
process in two smoothie bars: one operated by Jack and
People can produce fol tl-remselves all the goods and
services that they consulre, or they can produce one good
or a f'ew goods and trade with others. Producing only one
good or a few goods is called specialiscrtion.
We ale going to discover how people gain by special-
ising in the production of tlre good in which they have a
contparative adttantaF,e and trading with each other.
A person has a comparative advantage in an activity
ifthat person can perforrn the activity at a lower
opporturrity cost than anyolte else. Differences in oppor-
tnr.rity costs arise frorn c1ilI'erences in individual abili-
ties ancl from differences in the characteristics of other
fesoufces.
No one excels at everything. One person is an out-
stancling batter but a poor catcher; another person is a
brilliant lawyer but a poor teacher. In almost all human
endeavours, what one person does easily, someone else
finds difficult. The same applies to land and capital. One
plot of land is fertile but has no mineral depositsi another
plot of land has outstanding r,iews but is infertile. One
rnachine has great plecision but is difficult to operate:
anotl-rer is f'ast but often breaks down.
Although no one excels at everything, sorne people
excel and can outperlbrm others in a large number of
activities - perhaps all activities. A person who is more
productive than others has an absolute advantage.
Absolute advantage involves contpar-ir.rg productivities
proclr-rction per hour - whereas comparative advantage
ittrolvet cotnpaling oppo'lrrttit1 cosl.
A person who has an absolute advantage does not have
a con4tarative advantage in every activity. Andy Murray
can mn faster and play tennis better than rnost people.
He has an absolute advantage in these two activities. But
compaled with other people, he is a better tennis player
than ii rrrnner, so his contporative advantage is in playing
fennis.
Because people's abilities and the quality of their
l'esollrces differ. they have different oppoltunity costs of
prodr.rcing various goods and services. Such differences
give rise to comparative advantage.
To explore the idea of comparative advantage, and its
astonisl'ring implications, we'll look at the production
the other operated by Erin.
.facl<'s Smoothie Bar
Jack produces both smoothies and salads in a small
low-tech bar. Jack has only one blender, and it's a slow
old machine that keeps stopping. Even if Jack uses all his
lesorlrces to produce smoothies, he can produce only 6 an
hour - see Table 2.1. But Jack is good at making salads,
and if he uses all his resources to make salads. he can
produce 30 an hour.
Jack's ability to make smoothies and salads is the
same regardless of how he splits an hour between the two
tasks. He can make a salad in 2 rninutes or a smoothie in
10 minutes. For each additional srnoothie Jack produces,
he must decrease his production of salads by 5. And for
each additional salad he produces, he must decrease his
production of smoothies by | /5 of a smoothie. So
Jack's opportunity cost of producing 1 smoothie
is 5 salads.
and
.Iack's opportunity cost of producing I salad is
1/5 of a smoothie.
Jack's customers buy smoothies and salads in equal quan-
tities. So Jack spends -50 rninutes of each hour inaking
srnoothies and l0 minutes of each hour making salads.
With this division of his time, Jack produces -5 smoothies
and -5 salads an hour.
Figure 2.6(a) illustrates the production possibilities at
.lack's smoothie bar - .Toe's PPE
- Jack's PPF is linear (not outward bowed) because his
ability to produce salads and smoothies is the same no
matter how he divides his tirne between the two activities.
Jack's opportunity cost of a srrroothie is constant * it is
the same at all quantities of smoothies produced.
Table 2.1
Jack's Production Possi bi I ities
Minutes to 0uantity
Item produce 1 per hour
Smoothies 10 b
Salads 2 30
 CHAPTER 2 The Economic problem

Erin's 5nroothie Bar

Table 2.2
Erin also produces smoothies and salads. In Er.in's
high-tech bar, she can turn out either a smoothie or. a Erin's Production Possibilities
salad every 2 minr.rtes - see Table 2.2.
Minutes to Ouantity
If Erin spends all her tirne making smoothies, she Item produce 1 per hour
can prodnce 30 an hour. And if she spends all her time
making salads, she can also produce 30 an hour. Smoothies 2 30
Erin's ability to make smoothies and salads, like
Salads 2 30
Jack's, is the same regardless of how she splits her-
linie between the two tasks. She can make a salad in
2 minutes ol a smoothie in 2 rninutes. For each acldi-
tional smootl.rie Erin produces, she must decrease her
Erin's cnstomers buy smoothies and salads in equal
production of salads by one, and for. each aclclitional
quantities, so she splits her time equally between the two
:alad she produces, she must decrease her production of
items and ploduces 15 srnoothies and l5 salacls an hour.
smoothies by or.re. So
Figure 2.6(b) illustrates rhe production possibilities at
Erin's oplp,rrtilnity eost of producing n smoothie Erin's smoothie bar - Erin's PP,E
is I salauct" Like Jack's, Erin's PPF is linear because her ability to
produce salads and smoothies is the same no matter how
an,l
she divides her tirne between the two activities. Erin,s
Erin's rrplrortunity cost of producing I salad is opportunity cost of a srnoothie is I salad at all c1-raltities
I suroorhie. of smoothies produced.

Figure 2.6 The Production Possibilities Frontiers

t
I
3so
c o
.!1
- a( T n<
o LJ
o
Erin produces l5
smoothies ond
'15
solods ot on
opportun ity
cost o[ I solod
Jock produces 5 per smoothie
smoothies ond
5 solods ot on
opportun ity
cost of 5 solods
per smoolhie

Jock's E rin's
PPF
PPF

0 5 t0 15 20 25 30 051015202530
Smoothies (per hour) Smoothies {Per hour}
{o) Jock (b) Erin

Jeck can produce 30 salads per hour, 1 every two
minutes, if he produces no smoothies. Or, he can produce
6 smoothies per hour, 1 every 10 minutes, if he produces
no salads. Jack's customers buy equal quantities of
salads and smoothies, so he produces 5 of each. Jack's
opportunity cost of a smoothie is 5 salads.
Erin can produce either 30 salads or 30 smoothies per
hour, 1 of either item every two minutes. Erin's customers
buy equal quantities of salads and smoothies, so she
produces 15 of each. Erin's opportunity cost of a smoothie
is 1 salad.

I:i ,:rti
 PART 1 The Scope of Economics

ja, - l<'s Com parative Advantage Table 2.3

In rvhich of the two activities does Jack have a compara- Erin and Jack Gain fromTrade
tive advantage? To ernswet'this questittn, first recall the
dcf inition of compalative advantage. A person has a coln-
ia) Before tracie
parative iidvanta-9e whetr that person's opportunity cost of
Erin Jack
plotl.rcing a good is lower tlratt another person's opporttt- Smoothies 15 5
nitv coqt of producing tlrat same good.
Salads 15 5
Jack's opportunity cost of producing a salad is only 1/5
of a snroothie, while Erin's opportunity cost of producing {h} Speeia!isatiorn
a salad is I srlroothie. So .lack has a comparative advan- Erin Jack
tiigc- in ploducing salads. Smoothies 300
Salads 30
Eni n's eom parative Advantage lr,.'
(c) 'ii'acle
,|::

If .lack has a comparative advantage in producing salad, Erin Jack fir'l

then Erin must have a compat'ative advantage in produc- Smoothies sell '10 buy 10

in-s srroothies. Check the numbers. For Jack, a smoothie Salads buy 20 sell 20
costs 5 salads. and fot'Elin. a smoothie costs 1 salad. So
Erin has a comparative adviintage in making smoothies. (d) A.Feen tracXe

Erin Jack
Smoothies 20 10
l r 1. ;1I I : l ir,,,' ,' . 1, "i-i't,
-;l.,
20
Salads 10
E,rin and Jack run into each other ttne evening in a singles
(e) Gains from tracle
After a few rnitiutes of getting acquainted, Erin tells
bar'.
Jack about her arnazing suroothie business. Hel only Erin Jack
Smoothies +5 +5
problern, she tells Jack, is that sl.re wishes she could pro-
dnce rnore because potential customels leave when the Salads +5 +5
queue gets too long.
Jack is hesitiint to risk spoiling his chances by te lling
Erin about his own stluggling business, but he takes the is goocl for Jack, so a price of 2 salads per smoothie lets :

risk. Jack says he spends -50 nrinutes of every houl mak-
ing 5 smoothies and l0 tnir.rutes making 5 salads. Erin's
eyes pop. 'Have I got a deal for yon!' she exclaims.
Ei'in's Froposal
Here's the deal that Erin sketches on a serviette. Jack
stops rnaking smoothies and allocates all his tirne to pro-
clucing salads. Erin stops rnaking salads and allocates all
hel titne to producing smoothies. That is, they both spe-
cialise in ploducing the good in which they have a com-
palative advautage. Together they ploduce 30 smoothies
ancl 30 salads - see Tirble 2.3(b).
They then trade. Erin sttggests trading at a price of
2 salads per srnoothie. Fol I'rer, that is a good deal because
she can ploduce a stnoothie at a cost of I salad and sell it
to.lack fbr 2 salads. lt is also a good deal for Jack because
he can produce a salad at a cost of 1/5 of a srnoothie and
sell it to Elin for l/2 a sn-ioothie.
Elin explains that arty plice above I salad pel smoothie
is good for her and any price below -5 salads pel srroothie
them both gain, as she now describes.
At the proposed price, Erin off'ers to sell Jack
10 smoothies in exchange for 20 salads. Equivalently,
Jack sells Erin 20 salads in exchange for 10 srnoothies -
see Table 2.31c.1.
Afier this trade, Jack has 10 salads - the 30 he pro-
duces minus the 20 he sells to Erin. He also has the
l0 srnootl.ries that he buys from Erin. So Jack now has
increased the quantities of smoothies and salads that he
can sell to his custorners - see Table 2.3(d).
Erin has 20 smoothies - the 30 she produces rninus
the l0 she sells to Jack. She also has the 20 salads that
she buys frorn Jack. Erin lras increased the quantities of
smoothies and salads that she can sell to hel cttstomers -
see Tarble 2.3(d). Botlr Erin and Jack gain 5 smoothies and
-5 salads an houl- see Table 2.3(e).
lllustrating Erin's ldea
To illustrate her idea, Erin grabs a fresh serviette and
draws the graphs in Figr,rre 2.7. First, she sketches Jack's
 CHAPTER 2 The Economic Problem

I Figure 2.7 The Gains fromTrade

I

?
f, ^^
O JU -3so
J
0
o- go ii
T _" To a<
o '5 LJ
o
a qo
Jock buys i 0
smoolhies
from Erin

: lrode llne
A:
a":
:-lock's:
:PPF:

0 20 25 30 0 5 10 t5 ,i, 25 30
Smoothies (per hour) Smoothies {per hourl
(o! Jock (b) Erin

Jack initially produces at point A on his PPFin part (a), and
Erin initially produces at point Aon her PPFin part (b). Jack
has a comparative advantage in producing salads and Erin
has a comparative advantage in producing smoothies.
lf Jack specialises in salad, he produces 30 salads and
no smoothies at point I on his PPF. lf Erin specialises in
making smoothies, she produces 30 smoothies arrd no
salads, she produces at point B on her ppF.
They exchange salads for smoothies along the red ,Trade
line'. Each goes to point C- a point outside his or her ppE
Both Jack and Erin increase production by 5 smoothies
and 5 salads with no change in resources.

PPF in part (a) and shows the poinr ar which he is pro- With trade, Erin has 20 smoothies an<i 20 salads at
ducing before they meet. Recall that he is pr.oducing 5 point a gain
C - of 5 smoothies and 5 salads. Erin moves
smoothies and 5 salads an hollr at point A. to a point outsicle her PPF.
Erin then sketches her own PPF inpart (b), and marks Despite Erin being more productive than Jack, both
the pointA at which slre is producing 15 smoothies ancl Elin ar.rd Jack gain 1}om specialising in the production
15 salads an hour. of the good in which each has a corlparative advantage
She then shows what happens when tl"rey each spe- and then trading.
cialise in prodLrcing the good in which they have a com-
parative advantage. Jack specialises in producirlg salads
and pl'oduces 30 salads aud no smoothies at point ,B on
.l
his PPE '1 ,. l

Elin specialises in producing smoothies and produces

30 smoothies and no salads at point B on her PPfl
1 What gives a person a comparative advantage?
They then trade smoothies and salads at a price of 2 Distinguish between cornparative advantage and
2 salads per slnoothie or l/2 a smoothie per salad. The absolute advantage.
red 'Tlade line' that Erin draws on each part of the figure 3 Why do people specialise and trade?
illLrstrates the trade-ofT that each faces at the proposed 4 What ale the gains from specialisation and
price. trade?
Erin now shows Jach the amazing outcome of hel idea. 5 What is the source of the gains fiorn trade'?
After specialising and tlading, Jack gets l0 srnoothies
Do these questions in Study PIan 2.4 and get
and l0
salads at point C a gain of 5 smoothies and
- insiant feedbac!<. Do a Key Terrns Quiz. !. l. ! !

5 salads. He rnoves to a point outside outsicle his PPfl