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AP Macroeconomics
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Table of Contents
Unit 1 Overview: Basic Economic concepts
1.1 Scarcity
1.2 Opportunity Cost and the Production Possibilities Curve (PPC)
1.3 Comparative Advantage and Trade
1.4 Demand
1.5 Supply
1.6 Market Equilibrium, Disequilibrium, and Changes in Equilibrium

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1.3 Comparative Advantage and Trade

Verified for the 2025 AP Macroeconomics exam•Citation:

Countries will consequently increase its productions by engaging in trade. However, there are certain conditions that may provide advantages and disadvantages to some countries over others in the production of specific goods.

The concepts of absolute and comparative advantage are used to illustrate how individual countries or entities interact and trade with each other. These concepts also focus on how people specialize in what they are good at producing, and how they trade for goods and services that they are not as efficient at producing. Countries aim to gain competitive edge over others in the economy to gain more power in the global market.

There are two types of problems within these concepts: output and input. Output problems focus on data associated with what each party can produce with a given set of resources, as well as who should specialize in each good. Input problems focus on how much of a resource is needed to produce one unit of a particular good or service.

Output Problems

The rules for these problems are:

  • To determine the absolute advantage you are simply looking for which country can produce a higher amount of the good or service.
  • To determine comparative advantage you have to calculate per unit opportunity cost using the formula give up/gain (the amount of good you are giving up divided by the amount of good you are gaining). Once you have calculated per unit opportunity cost, the country with the lowest one has a comparative advantage.
  • If the two countries can both make the same amount of the good, then we say neither country has an absolute advantage.
  • Countries export what they have a comparative advantage in and import what they don't have a comparative advantage in.

Determining Absolute Advantage

Using the table above, we would determine that Japan has an absolute advantage in steel (1200 > 1000) and Canada has an absolute advantage in coal (500 > 300).

Determining Comparative Advantage

The per unit opportunity cost for steel in Canada is 1/2 a unit of coal (500/1000).

The per unit opportunity cost for steel in Japan is 1/4 a unit of coal (300/1200). 

Since 1/4 is less than 1/2, Japan has comparative advantage in steel.

The per unit opportunity cost for coal in Canada is 2 units of steel (1000/500).

The per unit of opportunity cost for coal in Japan is 4 units of steel (1200/300).

Since 2 is less than 4, Canada has comparative advantage in coal.

Japan will export steel to Canada and import coal from Canada.

Terms of Trade

Terms of trade are determined by looking at the two opportunity costs and choosing a number that falls between the opportunity costs in order for it to be beneficial to both countries.

Acceptable terms of trade for this situation would be:

  • 1 coal = 3 units of steel
  • 1 steel = 1/3 units of coal

Input Problems

The rules for these problems are:

  • To determine absolute advantage, you are looking for the country that uses the least amount of resources (i.e. the lower number).
  • To determine comparative advantage, you have to calculate the per unit opportunity cost using the formula gain/give up. Once you have calculated the per unit opportunity cost the country with the lowest one has a comparative advantage.
  • If the two countries can both make one unit of the good with the same amount of resources, then we say neither country has an absolute advantage.
  • Countries export what they have a comparative advantage in and import what they don't have a comparative advantage in.

Terms of Trade

It consists of the ration of a country's export prices to income prices and determines the relative price between that nation's exports and imports. 

Terms of trade are determined by looking at the two opportunity costs and choosing a number that falls between the opportunity costs in order for it to be beneficial to both countries.

Acceptable terms of trade for the situation described above would be:

  • 1 truck for 1.5 cars—this number is between 1, the comparative advantage for a truck in Brazil, and 2, the comparative advantage for a truck in the United States
  • 1 car for 3/4 of a truck—this number is between 1/2, the comparative advantage for a car in the United States, and 1, the comparative advantage for a car in Brazil

ToT (Terms of Trade) can be influenced by several factors, such as: exchange rates 🔁, changes in prices of raw materials🛢, and shifts in the global demand. 🌏 

A favorable terms of trade for a country means that it can purchase more imports for the same amount of exports, which can consequently boost its economy. A country with unfavorable terms of trade has to export more to purchase the same amount of imports, which is damaging to its economy. 

Key Terms to Review (4)

Absolute Advantage: Absolute advantage refers to the ability of an individual, firm, or country to produce more of a good or service than competitors using the same amount of resources. It emphasizes the efficiency in production capabilities that can lead to higher overall output, making it a key concept in understanding trade dynamics and comparative advantage. When one entity has an absolute advantage, it can specialize in the production of certain goods, which can influence trade relationships and economic strategies.
Export: An export is a good or service that is produced in one country and sold to another country. Exports play a vital role in international trade by allowing countries to benefit from their comparative advantages, leading to increased economic efficiency and specialization. When countries export, they can focus on producing goods and services that they can create most efficiently, while importing those that others produce better or cheaper.
Import: An import is a good or service brought into one country from another, often for the purpose of sale or consumption. Imports play a crucial role in global trade, allowing countries to acquire resources, products, and services that they may not produce efficiently themselves. By importing goods, nations can benefit from comparative advantage, where they focus on producing items at which they are most efficient while relying on trade to meet their other needs.
Opportunity cost: Opportunity cost is the value of the next best alternative that is forgone when making a choice. This concept plays a crucial role in decision-making, as it highlights the trade-offs involved in every economic decision. Understanding opportunity cost helps individuals and societies allocate scarce resources more effectively, balancing various needs and desires.