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Lecture 4

ECO101H1 Lecture Notes - Lecture 4: Absolute Advantage, Comparative Advantage, Opportunity Cost


Department
Economics
Course Code
ECO101H1
Professor
James Pesando
Lecture
4

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Lesson 4- Comparative Advantage and the Gains
from trade
Name Cloth Corn
John 10 2
Jane 16 8
Jane has Absolute Advantage in production of cloth and corn.
Question: Can Jane and John both still gain from trade?
Opportunity cost of John and Jane (example 2)
Name Cloth Corn
John 0.2 Corn 5 Cloth
Jane 0.5 Corn 2 Cloth
John's PPF is unchanged, so his opp cost is unchanged
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Jane is twice as productive in the production of both goods as example 1, so her opp cost are also
unchanged (students should confirm)
John has a COMPARATIVE ADVANTAGE in the production of cloth, while jane has a COMPARATIVE
ADVANTAGE in the production of corn
Before trade, John and Jane divide their time equally between production of cloth and corn.
Name Cloth Corn
John 5 1
Jane 8 4
Total 13 5
After trade, John specializes completely in the production of cloth, while Jane now allocates 75% of her
time to the production of corn.
Production (After trade)
Name Cloth Corn
John 10 0
Jane 4 6
Total 14 (+1) 6 (+1)
(one more than before)
Arithmetic of this example:
Jane allocate 75% of her time to corn and 25% of her time to cloth
Under this assumption, we can readily demonstrated that total output of cloth and corn increases, with
unchanged resources for John and Jane
*You wont be asked to find how out how much specialization ex. 75%
-Students will NEVER be asked to provide this type of illustration (that is to find the fraction of Jane's
time that must be allocated to corn in order for total output to increase)
-Students ARE expected to understand the importance of this arithmetic example
-In the case of complete specialization, we do not obtain an unambiguous signal as to the increase in
output if trade occurs
-If Jane allocated 100% of her time to corn and John allocated 100% of his time to corn, then total
output would be
Cloth: 10
Corn: 8
-Thus..
Cloth: = -3 (10 vs 13, if both allocate equal time to both goods)
Corn: +3 (8 vs.5, if both allocate equal time to both goods)
True or False:
If you can unload the dishwasher faster than your roommate, you should do so
Uncertain
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