Comparative Advantage and Trade

Vocabulary flashcards covering key concepts from the notes on specialization, division of labor and knowledge, the production possibilities frontier (PPF), opportunity cost, trade, and gains from trade.

Specialization

The focus of production on a single good or task to increase efficiency and enable trade.

Division of labor

Separation of production tasks among individuals to improve efficiency; a form of specialization; popularized by the Industrial Revolution.

Division of knowledge

Separation of knowledge across individuals; linked to division of labor and leads to advanced procedures and medicines; describes contemporary society.

Trade

The exchange of goods where each party values the other more, creating value by moving goods to those who value them more and enabling specialization.

Gains from trade

Benefits from specialization and exchange; post-trade consumption can exceed pre-trade possibilities, making both parties better off.

Production Possibilities Frontier (PPF)

A curve showing all possible output combinations with fixed resources and technology; indicates attainable, efficient, inefficient, and unattainable production points.

Attainable

Points on or inside the PPF that can be produced with available resources.

Efficient

A point on the PPF where resources are fully and efficiently utilized.

Inefficient

A point inside the PPF where not all resources are used to full capacity.

Opportunity cost

The value of the next best alternative forgone when producing more of one good; represented by the slope of the PPF.

Slope of PPF

Represents the trade-off between two goods; linear PPF has constant OC, bowed-out PPF has increasing OC.

Absolute advantage

The ability to produce more of a good with the same resources (or fewer resources) than another producer.

Comparative advantage

The ability to produce a good at a lower opportunity cost than another producer; drives specialization.

Beneficial rate of exchange

The range of exchange rates at which both trading parties benefit from the trade, lying between each party’s opportunity costs.

Post-trade consumption

Consumption that occurs after specialization and trade, often outside each individual’s pre-trade PPF, indicating gains.

Shifting the PPF

Movement of the PPF outward due to more resources, technological progress, better institutions, or more labor hours.

PPF assumptions

The model assumes only two goods, a fixed amount of resources, fixed technology, and full/efficient use of resources.