Chapter 3: Interdependence and the Gains from Trade

what does trade allow for?

it allows for specialization in what each country/individual does best, allowing everyone to consume more meat and potatoes without working more hours

absolute advantage

the producer that uses a smaller amount of inputs to produce a good than someone else has an absolute advantage in producing that good

opportunity cost

what you give up to get something

comparative advantage

the person with the lower opportunity cost to produce a good has a comparative advantage

is it possible to have an absolute advantage in both goods on the PPF?

yes

is it possible to have a comparative advantage in both goods?

no - this is because the opportunity cost of one good is the inverse of the opportunity cost of the other. so if one person’s opportunity cost is relatively high, then the other’s will be relative low

unless two people have the same opportunity cost, one person will have a comp advantage in one good and the other will have a comp advantage in the other good

if one person has an absolute advantage in both goods, how does trade still benefit both parties?

comparative advantage - when people produce goods in which they have a comparative advantage, total production rises and the economic pie grows largera

everyone can be better off

for both parties to gain from trade, what must the price be?

the price must lie between the opportunity costs for that good

ex. ruby opp cost for apples = 1/3 and frank’s opp cost for apples = 2

so, the price must be between 1/3 and 2

imports

goods produced abroad and sold domestically

exports

goods produced domestically and sold abroad

is interdependence desriable even though we have to rely on other countries?

yes, because it allows everyone to specialize in what they have a comparative advantage in, leading to improved economic productivity

the principle of comparative advantage answers what questions?

(1) is it possible for specialization and trade to benefit more than one party in a trade
(2) is it possible for specialization and trade to increase total output of traded goods
(3) is it absolute advantage or comparative advantage that really matters

**DOES NOT ANSWER: what determines the price at which trade takes place

The production possibilities frontier illustrates the combinations of output that an economy should produce.

True

False

False

production possibilities frontier illustrates the combinations of output that an economy CAN produce - not prescriptive just informative about the options.