Principles of Macroeconomics: Trade Theory

Flashcards covering key concepts from a lecture on international trade theory, including absolute and comparative advantage, opportunity cost, and terms of trade.

Why is international trade mutually beneficial?

It allows countries to specialize in producing what they do best and import the rest. This specialization leads to increased efficiency and production, generally resulting in a greater variety of goods and services at lower costs for consumers.

What is absolute advantage?

The ability to produce a product more cheaply (using fewer units of labor) than another country.

What is comparative advantage defined in terms of?

Opportunity costs. It refers to a country's ability to produce a good at a lower opportunity cost than another country, enabling beneficial trade.

Define opportunity cost.

The amount of one good that has to be given up in order to produce one more unit of another good, also given by the slope of the production possibility frontier.

When does Country A have a comparative advantage over country B?

When the opportunity cost of production in country A is lower (in terms of production foregone of the other product).

What does the slope of the production possibility frontier indicate?

The opportunity cost – how much of one good we need to give up in order to produce one more unit of the other good.

When do gains from trade arise?

Differing opportunity costs in the two countries. Gains from trade arise when countries specialize in the production of goods for which they have a comparative advantage, leading to increased overall efficiency and mutual benefits.

What are the sources of comparative advantage?

Factors such as differences in resource endowments, economies of scale, technological advancements, and specialized knowledge that allow certain countries to produce goods at a lower opportunity cost than others.

Define terms of trade.

The ratio between the index of export prices and the index of import prices.

What signifies a positive terms of trade?

Export prices increase more than import prices, allowing a country to purchase more imports for the same amount of exports.