ECON 1 Chapter Notes - Chapter 2: Absolute Advantage, Opportunity Cost, Comparative Advantage
5 May 2018
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Chapter 2 - The power of Trade and Comparative Advantage
Trade and Preferences
Trade creates value by moving goods from people who value them less to people who value them more
•
Trade makes people with different preferences better of
•
Specialization, productivity and the Division of Knowledge
The true power of trade is discovered only when people take the next step specialization
•
in a world without trade, no one can afford to specialize
•
People will specialize in the production of a single good only when they are confident that they will be
able to trade that good for the many other goods that they need
•
As trade develops, so does specialization
•
Specialization turns out to vastly increase productivity
•
Specialization greatly increases productivity
•
Without specialization and trade, we would have to produce our own food and goods --> the result
would be mass starvation and the collapse of civilization
•
It makes sense to divide knowledge across many brains and then trade
In primitive agricultural economy in which each person or household farms for themselves, each
person has about the same knowledge as the person next door
○
In this case the combined knowledge of a society of 1 million people barely exceeds that of a single
person
○
A society run with the knowledge of one brain is a poor and miserable society
○
•
In a modern economy, many millions of times more knowledge is used than could exist in a single brain
•
Knowledge increases productive so specialization increases total output
This is productive because each person can specialize in the reproduction of one good and then
trade for all other desired goods
○
•
The extent of specialization in a modern economy explains why no one knows the full details of how
even the simplest product is produced
Each person in a process knows only a small part of the whole
○
but with trade and market coordination, they each do their part without anyone needing to know
the whole process
○
•
Trade connects all markets •
The division of knowledge increases with specialization and trade •
Economic growth in the modern era is due to the creation of new knowledge •
One of the most momentous turning points in the division of knowledge happens when trade is
extensive enough to support large numbers of people
•
Comparative advantage
A third reason to trade is to take advantage of differences
Taking advantages of differences suggests that that world production world production can be
maximized when different country
○
•
Taking advantage of differences is even more powerful than it looks •
Absolute advantage: a country that can produce the same good using fewer inputs than another country
I.e.: since Martha Stewart is good at both ironing and running her business if she spent more time
ironing and less running her business her shirts might be pressed more precisely but that would be
a small gain compared with the loss from having someone else run her businesses
○
Its better for Martha if she specializes in running her business and then traded some of her income
for other goods such as ironing services
○
•
The production possibility frontier
Absolute advantage: the ability to produce the same good using fewer inputs than another producer •
production possibilities frontier (PDF) : all the combinations of goods that a country can produce given
its productive and supply of inputs
Illustrates trade-offs
○
Nether way of restating the fundamental principles of scarcity and Nether costs
○
•
Opportunity costs and comparative advantage
Ie: For every additional shirt that the US produces it must produce one fewer computer
○
One shirt has an opportunity cost of one computer
○
Comparative advantage: a country that has the lowest opportunity cost in producing goods
The theory of comparative advantage says that to increase its wealth a country should produce the
goods it can make a low cost and buy the goods that it can make at a high cost
○
A country (or a person) will always be the low-cost seller of some good
The greater the advantage a country has in producing A, the greater the cost to it of
producing B.
§
○
Countries with high productivity can lower productivity need never fear that higher-productivity
counties will outcompete them in the production of all goods
○
A country/people has absolute advantage over another country/person if it can produce more
output from the same input
○
What makes trade profitable is differences in comparative advantage, and a country will always
have some comparative advantage
○
•
Everyone can benefit from trade •
No person or country is so productive or so unproductive that they canot benefit from uclusionn in the
world-wide division of labor
•
Trade unites humanity •
Comparative advantage and wages
We can calculate wage by summing up the total value of consumption in a place and dividing it by the
number of workers
•
Productivity of labor determines the wage rate •
Specialization and trade let workers make the most of what they have-- it raises wages as high as
possible given productivity--
•
Trade does not directly increase productivity •
Workers fear trade because they think that they cannot compete with low-wage workers in other
countries
•
workers in low wage countries fear trade because they cannot compete with which productivity
countries
•
Differences in wages reflect differences in productivity •
High productivity countries have high wages, low 2•
Trade and Globalization
Takeaway
Chapter 2
Tuesday, September 20, 2016
12:09 PM
Chapter 2 - The power of Trade and Comparative Advantage
Trade and Preferences
Trade creates value by moving goods from people who value them less to people who value them more
•
Trade makes people with different preferences better of
•
Specialization, productivity and the Division of Knowledge
The true power of trade is discovered only when people take the next step specialization
•
in a world without trade, no one can afford to specialize
•
People will specialize in the production of a single good only when they are confident that they will be
able to trade that good for the many other goods that they need
•
As trade develops, so does specialization
•
Specialization turns out to vastly increase productivity
•
Specialization greatly increases productivity
•
Without specialization and trade, we would have to produce our own food and goods --> the result
would be mass starvation and the collapse of civilization
•
It makes sense to divide knowledge across many brains and then trade
In primitive agricultural economy in which each person or household farms for themselves, each
person has about the same knowledge as the person next door
○
In this case the combined knowledge of a society of 1 million people barely exceeds that of a single
person
○
A society run with the knowledge of one brain is a poor and miserable society
○
•
In a modern economy, many millions of times more knowledge is used than could exist in a single brain
•
Knowledge increases productive so specialization increases total output
This is productive because each person can specialize in the reproduction of one good and then
trade for all other desired goods
○
•
The extent of specialization in a modern economy explains why no one knows the full details of how
even the simplest product is produced
Each person in a process knows only a small part of the whole
○
but with trade and market coordination, they each do their part without anyone needing to know
the whole process
○
•
Trade connects all markets •
The division of knowledge increases with specialization and trade •
Economic growth in the modern era is due to the creation of new knowledge •
One of the most momentous turning points in the division of knowledge happens when trade is
extensive enough to support large numbers of people
•
Comparative advantage
A third reason to trade is to take advantage of differences
Taking advantages of differences suggests that that world production world production can be
maximized when different country
○
•
Taking advantage of differences is even more powerful than it looks •
Absolute advantage: a country that can produce the same good using fewer inputs than another country
I.e.: since Martha Stewart is good at both ironing and running her business if she spent more time
ironing and less running her business her shirts might be pressed more precisely but that would be
a small gain compared with the loss from having someone else run her businesses
○
Its better for Martha if she specializes in running her business and then traded some of her income
for other goods such as ironing services
○
•
The production possibility frontier
Absolute advantage: the ability to produce the same good using fewer inputs than another producer •
production possibilities frontier (PDF) : all the combinations of goods that a country can produce given
its productive and supply of inputs
Illustrates trade-offs
○
Nether way of restating the fundamental principles of scarcity and Nether costs
○
•
Opportunity costs and comparative advantage
Ie: For every additional shirt that the US produces it must produce one fewer computer
○
One shirt has an opportunity cost of one computer
○
Comparative advantage: a country that has the lowest opportunity cost in producing goods
The theory of comparative advantage says that to increase its wealth a country should produce the
goods it can make a low cost and buy the goods that it can make at a high cost
○
A country (or a person) will always be the low-cost seller of some good
The greater the advantage a country has in producing A, the greater the cost to it of
producing B.
§
○
Countries with high productivity can lower productivity need never fear that higher-productivity
counties will outcompete them in the production of all goods
○
A country/people has absolute advantage over another country/person if it can produce more
output from the same input
○
What makes trade profitable is differences in comparative advantage, and a country will always
have some comparative advantage
○
•
Everyone can benefit from trade •
No person or country is so productive or so unproductive that they canot benefit from uclusionn in the
world-wide division of labor
•
Trade unites humanity •
Comparative advantage and wages
We can calculate wage by summing up the total value of consumption in a place and dividing it by the
number of workers
•
Productivity of labor determines the wage rate •
Specialization and trade let workers make the most of what they have-- it raises wages as high as
possible given productivity--
•
Trade does not directly increase productivity •
Workers fear trade because they think that they cannot compete with low-wage workers in other
countries
•
workers in low wage countries fear trade because they cannot compete with which productivity
countries
•
Differences in wages reflect differences in productivity •
High productivity countries have high wages, low 2•
Trade and Globalization
Takeaway
Chapter 2
Tuesday, September 20, 2016
12:09 PM
Document Summary
Chapter 2 - the power of trade and comparative advantage. Trade creates value by moving goods from people who value them less to people. Trade makes people with different preferences better of. The true power of trade is discovered only when people take the next step specializ in a world without trade, no one can afford to specialize. People will specialize in the production of a single good only when they are confid able to trade that good for the many other goods that they need. Without specialization and trade, we would have to produce our own food and go would be mass starvation and the collapse of civilization. It makes sense to divide knowledge across many brains and then trade. In primitive agricultural economy in which each person or household farms f person has about the same knowledge as the person next door. In this case the combined knowledge of a society of 1 million people barely e person.
