AP Econ I Chapter 4 and 5 (comparative and absolute advantage & price elasticity) 12.03.25.

why do people trade? 

because you can’t make everything yourself 

• everyone should specialize in the production of g/s and trades for everything else.

• more trade = better standard of living

two ways to measure production

• input: what goes into making it (time)

• output: how MANY can you make (the good itself)

absolute advantage

who can produce more of something with the same resources

• productivity, efficiency

Adam Smith’s concept 

specialize and trade things you can make quicker and more of (absolute advantage). 

example of absolute advantage

• I can make 10 cookies in an hour. 

• Lahari can make 5 cookies in an hour. 

• I have absolute advantage in making cookies because I can make the most. 

comparative advantage

lower opportunity cost of making something

• the thing you’re giving up is not valuable so who gives up LESS

example of comparative advantage

• you can make cookies or cupcakes. 

  • I can make 1 cookie but I give up 3 cupcakes. 

  • Lahari can make 1 cookie but she gives up 1 cupcake. 

    • Lahari has comparative advantage of making cookies because she gives up less. 

overall differences between absolute and comparative advantage

• absolute advantage: who can make the most

• comparative advantage: who gives up the least to make it 

input vs. output

• input: how long does it take to produce 

• output: how much can they produce 

math application for absolute advantage

• input: who makes it quicker → absolute advantage

• output: who makes more → absolute advantage 

math application for comparative advantage 

• input: IOU → Input: Other goes Under 

• output: OOO → Output: Other goes Over 

based on the data, who should do which chore and why? base your answer only on the information above and on comparative advantage considerations

• based on the combinations, this will produce most at lower opportunity cost and take the least time. 

price elasticity of demand

determines how sensitive buyers are to a change in price

• if price changes, how much does quantity demanded change?

• do people still buy it if the price increases/decreases?

formula for elasticity of demand

what is quantity demanded?

the amount of a good/service that consumers are willing and able to buy at a specific price

elastic demand

• Qd changes a lot when prices change 

  • fancy restaurant meals, luxury items, etc 

  • elastic goods have substitutes so people switch easily 

inelastic demand

• Qd doesn’t change much when prices change 

  • gasoline, insulin, basic necessities 

what type of relationship do price and Qd have?

• negative relationship

  • As price decreases, Qd increases 

  • As price increases, Qd decreases 

when is demand inelastic and elastic?

• demand is more elastic at lower quantities (higher $) 

• demand is more inelastic at higher quantities (lower $) 

percent change formula

• end - start/ start x 100 

midpoint method

• use this when start and endpoints aren’t given 

• end value - start value/ midpoint value x 100 

1) perfectly inelastic demand

• Qd does not change when price changes 

  • price elasticity of demand (PED) =0

2) inelastic demand

• Qd doesn’t respond strongly to changes in price 

  • price elasticity of demand < 1

3) unit elastic 

• Qd changes by the same % as price changes 

  • price elasticity of demand = 1

4) elastic demand

• Qd responds strongly to changes in price 

  • price elasticity of demand > 1

5) perfectly elastic demand 

• Qd changes infinitely with any change in price 

  • price elasticity of demand = infinity 

determinants price elasticity of demand

(SNITT)

• S - substitutes ( a lot or a few?)

• N - necessity vs. luxury 

• I  -  income share (portion of income) - ( don’t need to know?) 

• T -  type of market (broad or narrow?) 

• T -  time horizon - elasticity is higher in the long run than in the short run 

supply determinants

• (FAC)

• F - flexibility of production

• A - availability of inputs

• C - capacity

why does price elasticity of demand matter? 

• helps firms predict how consumers will react to price changes → affects revenue

why does price elasticity of supply matter? 

• helps firms know how quickly they can increase production when prices rise

total revenue

• price x quantity demanded