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Lecture 2

ECO101H1 Lecture Notes - Lecture 2: Gumdrop, Absolute Advantage, Comparative Advantage

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Jack Carr

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Production Possibilities Frontier (PPF)
1. Scarcity (attainable vs. not attainable)
2. Tradeoffs (choices - decisions)
3. Opportunity cost
Key Application
Used to illustrate the benefits of trade, between countries and between individuals
Constant Opportunity Cost
Gumdrops Chocolates
10 0
8 1
6 2
4 3
2 4
0 5
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
Straight-line (linear) PPF implies that these opportunity costs do not change along the PPF
To simplify examples in class:
I assume that opportunity costs are constant along the PPF (and, thus, the PPF is linear)
For discussion of PPF that is not linear, see Mankiw, Chapter 2, pages 26-28
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:
o Specialization
o The gains from trade
Production Possibilities (per week)
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Cloth Corn
John 10 2
Jane 8 4
John has an absolute advantage in the production of cloth (i.e., is more efficient in the
production of cloth)
Jane has an absolute advantage in the production of corn
PPF: John and Jane
Opportunity Costs of Producing One Unit of:
Opportunity cost (1 cloth) = (2 / 10) = 0.2 corn (give up / get)
Opportunity cost (1 corn) = (10 / 2) = 5 cloths
Opportunity cost (1 cloth) = (4 / 8) = 0.5 corn
Opportunity cost (1 corn) = (8 / 4) = 2 cloths
John has a comparative advantage in the production of cloth (since he can produce cloth
at a lower opportunity cost, 0.2 corn versus 0.5 corn)
Jane has a comparative advantage in the production of corn (since she can produce
corn at a lower opportunity cost, 2 cloths versus 5 cloths)
Before trade: John and Jane each divide their time equally between the production of cloth and
Production (Before Trade)
Cloth Corn
John 5 1
Jane 4 2
Total 9 3
Suppose John and Jane specialize in the production of the good in which each has a
comparative advantage (and produce only this good), and then agree to trade
Production (After Trade)
Cloth Corn
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