ECO101H1 Lecture 3: Lecture 3-Comparative Advantage and the Gains from Trade
Friday, September 18th, 2009.
Comparative Advantage and the Gains From Trade
Principles of Economics
Interaction Among Individuals
1. Trade can make everyone better off (³JDLQVIURPWUDGH´
Specialization
Individuals: Produce one (or few) goods
Purchase many goods
Countries: Export goods
Import goods
Trade/Exchange
Source of gains from trade/exchange:
Comparative Advantage
Production Possibilities Frontier
(Constant Opportunity Cost)
Gumdrops
Chocolates
10
0
8
1
6
2
4
3
2
4
0
5
0
2
4
6
8
10
12
0 1 2 3 4 5 6
Chocolates
Gumdrops
Not
Attainable
Attainable
PPF
www.notesolution.com
(1) scarcity
(2) trade-off
(3) opportunity cost
Suppose:
1. Switch from all Gumdrops to all Chocolates
Opportunity cost of one Chocolate = 10/5 = 2 Gumdrops
2. Switch from all Chocolates to all Gumdrops
Opportunity cost of one Gumdrop = 5/10 = 0.5 Chocolates
Opportunity cost of gumdrops: 0.5 chocolates
Opportunity cost of chocolate: 2 gumdrops
Note: Straight-line (linear) PPF implies that these opportunity costs do not change along
the PPF.
Production Possibilities Frontier
(Increasing Opportunity cost)
Possibility
Games
Missiles
A
0.0
4.0
B
1.0
3.8
C
2.0
3.5
D
3.0
3.0
E
4.0
2.0
F
4.6
1.0
G
5.0
0.0
xxxxxxxxxx
xxxxxxxxxx
xxxxxxxxxx
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
0 1 2 3 4 5 6
Video Games
Missiles
b
c
d
e
f
g
PPF
a
www.notesolution.com
From a to b:
Opportunity Cost = ¨missiles = 0.2 = 0.2 missiles
JDPH¨games 1.0
From f to g:
Opportunity cost = ¨missiles = 1.0 = 2.5 missiles
JDPH¨JDPHV0.4
Conclusion: Source of Increasing Opportunity Cost
Resources most suited to the production of a good are used first. As more
of good is produced, resources less suited to its production must be used.
For Simplicity
Assume constant opportunity cost
< = >
Straight-line PPF
Comparative Advantage and the Gains from Trade
Key Result
An individual (or country) has a comparative advantage in an activity if
the individual (or country) can perform that activity at a lower opportunity cost
than anyone else.
The existence of comparative advantage is the key to:
(1) Specialization
(2) The gains from trade
Example:
PPF: John and Jane
Production Possibilities (Per Week)
Cloth
Corn
John
10
2
Jane
8
4
www.notesolution.com
98
ECO101H1 Full Course Notes
Verified Note
98 documents
