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ECN 104 Chapter Notes -Absolute Advantage, Opportunity Cost, Comparative Advantage


Department
Economics
Course Code
ECN 104
Professor
Amy Peng

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Scarcity means that we have to make choices
having more of one good thing usually means having less of another.
Trade-offs are widespread and important
Economics: the study of how people make choices under conditions of scarcity and of the results of
those choices for society.
CostBenefit Principle: An individual (or a firm or a society) will be better off taking an action if, and only
if, the extra benefits from taking the action are greater than the extra costs.
The result of the thing you didn’t pick
Economists often use abstract models of how an idealized rational individual would choose among
competing alternatives.
o Many economic models are examples of positive economics.
Positive economics has two dimensions
It offers cause-and-effect explanations of economic relationships.
It has an empirical dimension.
o Other economic models are examples of normative economics.
Such models overlap with positive economic models.
But they incorporate valuation of different possible outcomes. They lead to normative
statements about what "ought" to be: say, what is best, what is most socially efficient,
or what is optimal.
Hence they have an element which cannot be tested with empirical evidence.
Two logical errors are to be avoided when modelling economic relationships.
The fallacy of composition - occurs if one argues that what is true for a part must also be
true for the whole.
The post hoc fallacy - occurs if one argues that because event A precedes event B, event
a cause’s event B.
Microeconomics studies subjects like
Choices of individuals
Choices of Firms
The determinants of prices and quantities in specific markets
Macroeconomics studies subjects like
The performance of national economies
o Long run growth and prosperity
o Short run booms and busts
Government policies to change performance
Sunk cost is a cost that is already irretrievably committed at the moment a decision must be made.
should NOT be counted for decision-making purposes
Marginal cost - the increase in total cost that result from carrying out one additional unit of an activity
Marginal benefit - the increase in total benefit that results from carrying out one more unit of an activity

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Average cost - total cost of undertaking n units of an activity divided by n
Average benefit - total benefit of undertaking n units of an activity divided by n
Opportunity Cost: The value of the next-best alternative that must be forgone in order to undertake an
activity.
Rational decisions depend upon opportunity costs
Opportunity cost is value of the next best alternative
OCnuts = loss in sugar canes/gain in nuts
In expanding the production of any good, first employ those resources with the lowest
opportunity cost, and only afterward turn to resources with higher opportunity costs
Greater production of one good results in rising opportunity cost of producing more of that
good
Absolute advantage - One person has an absolute advantage over another if he or she takes fewer hours
to perform a task than the other person does.
Comparative advantage - One person has a comparative advantage over another if his or her
opportunity cost of performing a task is lower than the other person’s opportunity cost.
When each producer concentrates on the activities for which opportunity cost is lowest,
aggregate output is maximized.
This holds even when one has absolute advantage over others at everything. Specialization
where there is comparative advantage is still the best route!
When we all focus where we are relatively more productive, together we can produce vastly
more than if we insisted on self-sufficiency.
Sources for CA:
For individuals
Inborn talent plays a role but only to start | Acquired skills “Human Capital”
are crucial
Similarly for countries, comparative advantage stems from:
Accumulated Physical and Human Capital; Difference in cultures and social
institutions; Noneconomic factors
Production Possibilities Curve - A graph that describes the maximum amount of one good than can be
produced for every possible level of production of the other good

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Attainable point - Any combination of goods that can be produced using currently available resources
Unattainable point - Any combination of goods that cannot be produced using currently available
resources
Efficient point - Any combination of goods for which currently available resources do not allow an
increase in the production of one good without a reduction in the production of the other
Inefficient point - Any combination of goods for which currently available resources enable an increase
in the production of one good without a reduction in the production of the other
PPC Combined
Production Possibilities Curve for a Large Economy
Downward-sloping: Shows scarcity principle
How Does Specialization Enhance Standards Of Living?
Opportunity costs for a given amount of output is reduced, the amount of good of services for
given resources is increased.
Specialization deepens existing skills through practise and experience, and it eliminates the
switching and start-up costs
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