Comparative Advantage and Trade Notes

The Production Possibilities Frontier (PPF) is a graph that shows the combinations of two goods that an economy can possibly produce given the available resources and the available technology.
Example with Butter and Guns:
- If all resources are used for butter, the economy can produce 100 units of butter and 0 guns.
- If all resources are used for guns, the economy can produce 1000 units of guns and 0 butter.
- Various combinations are possible (97 butter & 200 guns, 90 butter & 400 guns, 80 butter & 600 guns, 60 butter & 800 guns, 0 butter & 1000 guns), illustrating the trade-off.
Efficiency:
- Points on the PPF are efficient; resources are fully utilized.
- Points inside the PPF are inefficient; resources are not fully utilized.
- Points outside the PPF are unattainable with current resources and technology.

A simplified PPF can be represented as a straight line, making analysis easier.
Example with Cars and TVs:
- Country 1 can produce 800 cars and 0 TVs or 400 TVs and 0 cars.
- Combinations include 600 cars & 10 TVs, 400 cars & 20 TVs, 200 cars & 30 TVs, 0 cars & 40 TVs.

Different countries have different PPFs based on their resources and technology.
Example with Country 2 (Cars and TVs):
- Country 2 can produce combinations such as 0 cars & 400 TVs, 20 cars & 300 TVs, 40 cars & 200 TVs, 60 cars & 100 TVs, 80 cars & 0 TVs.
Opportunity Cost:
- Opportunity cost of a car in Country 2: the number of TVs that must be forgone to produce one more car.
- Opportunity cost of a TV in Country 2: the number of cars that must be forgone to produce one more TV.

Absolute Advantage: The ability to produce a good using fewer inputs than another producer.
Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

In the example:
- Country 1: Opportunity cost of a car is 20 TVs; opportunity cost of a TV is $\frac{1}{20}$ car.
- Country 2: Opportunity cost of a car is 5 TVs; opportunity cost of a TV is $\frac{1}{5}$ car.
Country 2 has a comparative advantage in cars (lower opportunity cost).
Country 1 has a comparative advantage in TVs (lower opportunity cost).

Countries should specialize in producing goods for which they have a comparative advantage.
Country 2 should specialize in cars.
Country 1 should specialize in TVs.

Acceptable trading price: determined by the opportunity costs in each country such that both countries benefit from the trade
A trade occurs such that Country 1 trades some TVs for some cars from Country 2.
After the trade, each country consumes a combination of TVs and cars that is more than what they could have produced on their own.

The gains from trade are illustrated by consumption points outside the original PPFs of each country.
Example:
- Country 1 specializes in TVs, producing 400 TVs and 0 cars.
- Country 2 specializes in cars, producing 80 cars and 0 TVs.
- Through trade, both countries can consume beyond their individual PPFs.

Orange Country and Purple Country Example:
- Orange Country PPF:
  - 0 million apps, 6 million chips
  - 4 million apps, 4 million chips
  - 8 million apps, 2 million chips
  - 12 million apps, 0 million chips
- Purple Country PPF:
  - 0 million apps, 3 million chips
  - 3 million apps, 2 million chips
  - 6 million apps, 1 million chips
  - 9 million apps, 0 million chips
Tasks:
- Determine absolute advantage.
- Determine comparative advantage.
- Determine how much each country produces if fully specialized.
- Determine a feasible trading price.
- Determine the quantity traded.
- Determine the quantity consumed after trade.
- Calculate the gains from trade.
Assumptions:
- Same resources.
- Complete specialization.