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ECON 110 Study Guide - Final Guide: Factor Endowment, Autarky, Absolute Advantage

Course Code
ECON 110
Ian Cromb
Study Guide

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Gains from trade
- Form the basis for all consumption beyond subsistence level
o At the individual level if we did not specialize and trade (the division of labour)
we would each have to be economically self-sufficient
Produce everything we consume
o Development of markets within economies
Arise spontaneously due to the gains form specialization and trade
- Same logic holds at other levels
o Inter-regional level
o International level
An individual example
Autarky (no trade)
- Crusoe and Friday are each alone at opposite ends of an island
- Crusoe can produce either 10 coconuts or 5 fish a day (or any linear combination)
- Friday can produce either 5 coconuts or 10 fish a day (or any linear combination)
In autarky (ith o trade), eah perso’s PPB is also his Cosuptio Possiilities Boudary
- Suppose in autarky, Crusoe chooses 2 fish and 6 coconuts, Friday chooses 6 fish and 2
o Total outputs in autarky is 8 fish and 8 coconuts
- Voluntary trade brings the 2 into the same economy
- The gains from trade allow the two to reach the economy-wide PPB
Gains from trade specialization and trade
- Suppose Crusoe transfers 1/5 of his time from fish to coconuts and Friday transfers 1/5
of his time from coconut to fish.
- Changes in production
- This change moves them closer to the economy-wide PPB and the additional output is a
measure of the gains from trade.
- Would arise spontaneously due to the difference in opportunity costs for the two
It would cause Friday to produce more fish and trade for coconuts and would cause Crusoe to
produce more coconuts and trade for fish
- Both would be better off they are sharing the gains from trade
- In this way, trade allows for the division of labour and generates gains for the economy
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- We can also see how non-linear PPBs come about (imagine an economy with many
people each of whom has a slightly different individual linear PPB).
A Possible Final Trade Outcome
- Suppose the two agree on a trade price of 1 C per F (1 for 1)
- And at that price each would prefer to consume 5 unite of each good
- Crusoe exports coconuts and imports fish
- Friday exports fish and imports coconuts
- Or if we think them of them as being now in the same economy:
o Crusoe is a seller of Cs and a buyer of Fs
o Friday is a seller of Fs and a buyer of Cs
Absolute and Comparative advantage
- In our example above that Crusoe was better at producing coconuts and Friday was
better at producing fish.
- Crusoe could produce a coconut in 1/10 of a day while Friday took 1/5 of a day.
- Friday could produce a fish in 1/10 of a day; Crusoe took 1/5 of a day.
- Crusoe had an absolute advantage in the production of coconuts and Friday had an
absolute advantage in the production of fish.
Absolute advantage
- A producer has an absolute advantage when
o It has a resource cost of production (as above) or, equivalently
o Higher productivity (more output per unit of input)
- It turns out that this is not really important to the generation of the gains from trade
- What is important is comparative advantage having a lower opportunity cost
- What generated the gains above was the fact that Crusoe had a lower opportunity cost
of coconuts and Friday had a lower opportunity cost of fish
Comparative advantage
- A producer has comparative advantage in production of a good when it has a lower
opportunity cost of producing that good compared to another producer
- Given the reciprocal nature of opportunity cost, this implies that the other producer has
a comparative advantage in the production of the other good.
Is it comparative advantage that leads to the gains from trade?
- Shown in the following international level example
International level example
- Suppose that per unit resources, France can produce 4 cases of red wine or 2 cases of
white wine.
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