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ECON102 Lecture Notes - Lecture 3: Absolute Advantage, Comparative Advantage, Opportunity Cost

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School
University of Waterloo
Department
Economics
Course
ECON102
Professor
Ken Jackson

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ECON102 Full Course Notes
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Document Summary

Specialization and trade: trade allows firms to specialize in doing what they do best in order to consume more goods and services with less inputs. Absolute advantage: the comparison among produces of a good according to their productivity. Opportunity cost and comparative advantage: it is possible for one person to have an absolute advantage in both goods, but it is impossible for one person to have a comparative advantage in both goods. If a person s opportunity cost of one good is relatively high, his opportunity cost of the other good must be relatively low. Comparative advantage: the comparison among produces of a good according to their opportunity cost. Comparative advantage and trade: the gains from specialization and trade are based on comparative advantage. When each person specializes in producing the good for which he or she has a comparative advantage, total production in the economy rises.

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Related Questions

The law of comparative advantage states that:

a. each country should specialize in producing the good with the lowest opportunity cost.

b. a country that is able to produce something using fewer resources than other countries would gain from specialization and trade.

c. international trade barriers slow the introduction of new goods and better technologies.

d. countries can gain from trade if production is subject to economies of scale.

e. countries must agree on how much of one good exchanges for another.

Use the figure below to answer the following question(s). Table 2.4 The planets of Vulcan and Romulus each produce goods X and Y. The following table gives points on their production possibilities frontiers. V- X-2 of y X-1.5 of y y-half of x y-2 thirds of x Vulcan Romulus Good X Good Y Good X Good Y 33) 33) Refer to Table 2.4. Which one of the following is true? A) Vulcan has a comparative advantage in the production of X. B) Romulus has both an absolute advantage and a comparative advantage in the production of Y. C) Vulcan should specialize in the production of X. D) Romulus has both an absolute advantage and a comparative advantage in the production of X. E) Romulus has a comparative advantage in the production of X.

Discuss and explain the difference between the two.

The principle upon which Adam Smith first claimed that free trade benefits all countries. It holds that a country benefits from trade when it produces a particular good at a lower cost (in terms of labor input) than it costs to produce the good in any other country. By specializing the in the production and export of this good and importing goods whose production costs are higher than in other countries, the country can consume more of both goods. In trade theories, this principle was later replaced by the principle of comparative advantages.

Comparative Advantage is first fully stated by David Ricardo in the early nineteenth century, this concept holds that a country has a comparative advantage in a good if it can produce that good more cheaply than it can produce other goods. By specializing in the production of goods in which it holds a comparative advantage and importing the other goods, the country can consume more of all goods. In contrast to Adam Smith, therefore, this principle states that a country need not have an absolute advantage in any good to benefit from trade. The principle provides a powerful justification for liberal international trade by asserting that all countries benefit from such trade.