Gains from Trade: Efficiency, Opportunity Costs, and Comparative Advantage in Economics

Allocative Efficiency

Goods that allow consumers to maximize their happiness (utility)

Tradeoffs

What you must give up to get something else

Production Possibility Set (PPS)

All combinations of two goods given their resource

Production Possibilities Frontier (PPF)

Points on the PPS that are productively efficient

Opportunity Costs

What you must give up to get an item

Absolute Advantage

A producer has the absolute advantage when they make the goods better (quality, quantity and resource wise)

Comparative Advantage

A producer has comparative advantage if their good has a lower opportunity cost

Specialization and Trade

Deciding which producer has each advantage in each good, or one producer has both advantages

Terms of Trade

Determining which outcome (with or without trade) benefits both producers

Efficiency

The property of society getting the most it can from its scarce resources

Equity

The property of distributing economic prosperity fairly among the members of society

Homer's Choice Example

Choosing between beer or donuts to illustrate opportunity costs

Slope of PPF

Calculating the slope of PPF = change in y-intercept / change in x-intercept

Inverse Slope of PPF

1/slope PPF = -1

Candy Experiment

Example of allocative efficiency where individuals trade candy to maximize their utility

Student Time Allocation Example

Example of simple tradeoffs in decision making

Parents Income Allocation Example

Example of simple tradeoffs in decision making

Guns vs Butter

Example of society tradeoffs between production of consumer goods/services or national defense

Maximizing Production

PPS and PPF show how someone can maximize how much of 2 goods they can produce

Specialization in Goods

Comparative advantage shows who should specialize in each good if they have a lower opportunity cost

Absolute Advantage in Goods

Absolute advantage shows who should specialize in each good if they can produce it better