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Lecture 3

COMMERCE 1AA3 Lecture Notes - Lecture 3: Tiger Woods, The O.C., Opportunity Cost


Department
Commerce
Course Code
COMMERCE 1AA3
Professor
Emad Mohammad
Lecture
3

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Microeconomics – Lecture 3/Chapter 3 (Gains from Trade)
When we talk about trade, we talk about ways countries gain from trade
Supposed there are 2 people in the economy:
oThe potato farmer
oThe meat rancher
Opportunity cost of producing each good for each person:
oFor farmer:
To get 32 potatoes, give up 8 meat
To get 1 potato, give up ¼ meat
The opportunity cost of a potato = ¼ meat
The opportunity cost of a meat = 4 potatoes
oFor Rancher:
To get 48 potatoes, give up 24 meat
To get 1 potato, give up ½ meat
The opportunity cost a potato = ½ meat
The OC of a meat = 2 potato
Opportunity cost of
potato
Opportunity cost of a
meat
farmer ¼ meat 4 potatoes
Rancher ½ meat 2 potatoes
Comparative Advantage (CA)
oThe ability to produce a good with a lower OC than somebody else.
Therefore the farmer has a CA in potatoes whereas the rancher
has a CA in meat
Absolute Advantage
oThe ability to produce a good with a smaller quantity of inputs
oAA is useless to decide whether trades should take place or not
Trade and CA
oGains from specialization and trade are based on CA only
oCannot have a comparative advantage in both goods!
oRancher has an AA in both goods, but there are still gains to be made
from trade
oFarmer should specialize in producing potatoes and trade/export
potatoes for meat (Import)
oRancher should specialize in producing meat and trade/export meat
for potatoes (Import)
oGeneral Rule:
For both parties to gain from trade, the price at which they
trade must lie between the two opportunity costs.
oThey agree on a price of 15 potatoes for 5 meats
o15/15=5/13
o1=1/3
Should Tiger Woods Wash his own car?
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