EC120 Lecture Notes - Lecture 3: Absolute Advantage, Comparative Advantage, Opportunity Cost
EC120 – Chapter 3: Interdependence and the Gains form Trade
- Interdependence: Every day you rely on people from around the world to provide you with the
goods and services you enjoy.
- Recall one of the ten principles from chapter 1: Trade can make everyone better off.
- Now we will see why people – and countries – choose to be interdependent, and how they can
gain from trade.
- There are two ways to satisfy our wants: be self-sufficient, and specialize in trade and
production for what we want.
- How much of both goods should each country produce and consume if each country: chooses to
be self-sufficient or trades with the other country.
- How do we compare consumption without trade to consumption with trade: First, we need to
see how much goods is produced and traded between 2 countries.
- Exports: Goods produced domestically and sold abroad.
• To export means to sell domestically produced goods abroad.
- Imports: Goods produced abroad and sold domestically.
• To import means to purchase goods produced in other countries.
- Conclusion: Trade makes countries better off.
- Countries would be able to consume more than they could initially (independently).
- Absolute Advantage: the ability to produce a good using fewer inputs than another producer.
• Canada has an absolute advantage in wheat. E.g. producing 1 ton of wheat uses 10 labour
hours in Canada vs. 25 in Japan.
• If each country has an absolute advantage in one good and specializes in that good, then
both countries can gain form trade.
- Which country has an absolute advantage in computers?
• Again, Canada: producing one computer uses 100 labour hours in Canada vs. 125 in Japan.
• Canada has an absolute advantage in both goods.
- Why does Japan specialize in computers? Why do both countries gain from trade?
- Two countries can gain from trade when each specializes in the good it produces at lowest cost.
• Absolute advantage measures the cost of a good in terms of the inputs required to produce
it.
- Recall: Another measure of cost is opportunity cost.
- Here, the opportunity cost of a computer is the amount of wheat that could be produced using
the labour needed to produce 1 computer.
- Comparative Advantage: The ability to produce a good at a lower opportunity cost than another
producer.
- Which country has the comparative advantage in computers?
• We must figure out the opportunity cost of a computer in each country.
- Opportunity Cost of a Computer: In Canada, the opportunity cost is 10 tons of wheat. 100 labour
hose produces 1 computer or 10 tons of wheat.
- In Japan, the opportunity cost is 5 tons of wheat. 125 labour house produces 1 computer or 5
tons of wheat.
- Japan has a comparative advantage is not necessary for comparative advantage.
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Document Summary
Ec120 chapter 3: interdependence and the gains form trade. Interdependence: every day you rely on people from around the world to provide you with the goods and services you enjoy. Recall one of the ten principles from chapter 1: trade can make everyone better off. Now we will see why people and countries choose to be interdependent, and how they can gain from trade. There are two ways to satisfy our wants: be self-sufficient, and specialize in trade and production for what we want. How much of both goods should each country produce and consume if each country: chooses to be self-sufficient or trades with the other country. How do we compare consumption without trade to consumption with trade: first, we need to see how much goods is produced and traded between 2 countries. Exports: goods produced domestically and sold abroad: to export means to sell domestically produced goods abroad.
