Lesson 6: Absolute and Comparative Advantage

why is an economy of one inefficient

Need to do everything themselves

Gains from trade

Experienced by economies with more than one individual (compare before specialization with after trade). The extra output that trading partners obtain thru specialization of production and exchange of goods and services

Specialization

Division of tasks and labor; a situation in which different people each engage in a different task. The use of resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services

What is PPC particularly useful for?

Illustrating gains from trade-trade based on comparative advantage

Difference between absolute advantage and comparative advantage

• An individual has an absolute advantage in producing a good or service if they can make more of that good/service with a given amount of time and resources (nothing to do with trade)

• An individual has an comparative advantage in producing a good or service if the OC of producing good/service is lower for that individual than for the other party/parties

2 ways to measure productivity

1. input method

2. Output method

Input method

Measured by the amount of inputs (usually time) necessary to do an activity (Ex. # of hours to do a job, # of gallons of paint to paint a house)

Want these #s to be small for success

Calculate A/B first for OC

Output method

Measured by the output over a given period of time (ex. Tons per acre, words per min)

Want as large a # as possible to show success

First calculate B/A for OC

How can we remember which direction to divide?

• Take the phrase “In & Out” and imagine that at top of punnet square

• “In” = (A) column; “Out”= (B) column

• Determine what method should be used based on situation/info provided

• Input = A/B first; Output= B/A first (2nd OC will be reciprocal)

Why should one party produce the produce with the lower OC and trade for the other product?

They’re ultimately giving up LESS to produce the thing theyre producing allowing them to trade for the other item and be better off overall

• Specialization in producing a product with lower OC produces more products than any other combination of production

How do you figure out the terms of trade?

Find the OC for each good for each party then determine from there (Lower # for how much needed to give up; higher # for how much to get)

Absolute advantage

One individual or nation can produce more output with the same resources as another individual or nation

Comparative advantage

One individual or nation can produce a good at a lower opportunity cost than another individual or nation

Terms of trade

The rate at which units of one product can be exchanged for units of another product; the amount of one good or service that must be given up to obtain one unit of another good or service