Comparative Advantage & Absolute Advantage-Samples for Students

Questions: 1.As a producer why is it important to consider the Price Elasticity of demand of your product when selling the price you are going to change? 2.Explain the difference between Comparative advantage and absolute advantage? Answers: The Price elasticity of demand (PED) portrays the capability of quantity demanded to react to deviations in the price. This measure exhibits how much the quantity bought increases or declines due to a price fall or hike. Producers make use of PED to make revenue maximizing decisions.(Case, Fair, Oster, 2014). Elastic Demand For a commodity whose PED is elastic, then a small variation in the price results in a significant shift in the quantity purchased(Arnold, 2013). In such cases, the consumers are highly responsive to changes in the price. This scenario usually occurs when a good is non-essential or easily substitutable. Therefore, for an elastic product, the producer can maximize revenue by lowering the price. On the figure one above, if the producer reduces the price of an elastic commodity from $1.50 to $0.85, then the quantity purchased increases from 3 units to 10 units. More units are consumed at a relatively low price and thus more revenue generated. Inelastic Demand For a product whose PED is inelastic, then a large deviation in the price results in a little variation in the quantity purchased(Arnold, 2013). Since the buyers are unresponsive to price fluctuations, the producer can maximize revenue by increasing the price. On the chart two above, a hike in the price from $1.55 to $3.67, results in a small drop in the quantity purchased. At a price of 3.67 U.S Dollars, the enterprise will get more proceeds than at a price of $1.55. 2.Comparative Advantage vs. Absolute Advantage Absolute advantage entails a situation where an entity or a country can generate goods and services at a lower cost per unit in comparison to another entity or a country. A country or a firm that has an absolute advantage is known to generate goods and services using highly efficient processes or with fewer inputs(Kleindl, Burrow, Dlabay, 2016). For example, if both Spain and India are manufacturers of vehicles, but Spain can create cars at a faster rate and of higher quality than India, then Spain has an absolute advantage. On the contrary, comparative advantage entails the ability of a country to make merchandises at a reduced opportunity cost than another country. Lower opportunity cost is grounded on the capacity of a country to specialize in generating products using a limited amount of resources. In this situation, the opportunity cost incorporates the benefits that are surrendered as a result of making one choice(Mankiw, 2014). Assume that Spain and India have sufficient resources to generate either coffee or wine, though not both. India can make 32 units of coffee or 25 units of wine whereas Spain generates 22 units of coffee or 13 units of wine. Then Indias opportunity cost for every unit of coffee is 25/32 (0.78) while that of wine is 32/25 (1.28). On the other hand, Spains opportunity cost for coffee is 13/22 (0.59) while that of wine is 22/13 (1.69). In this case, Spain holds a comparative advantage in the making of coffee while as India holds a comparative advantage in wine. Bibliography Arnold, R. A. (2013). Economics. Mason, Ohio: South-Western. Case, K. E., Fair, R. C., Oster, S. M. (2014). Principles of economics. Harlow, England: Pearson. Kleindl, B., Burrow, J., Dlabay, L. R. (2016). Principles of business. Mason : South-Western Educational Publishing. Mankiw, N. G. (2014). Principles of economics. Stamford, CT : Cengage Learning.