Comparative Advantage and Trade Lesson 1.4

Gains From Trade We all benefit from Trade, simply because we cannot do everything ourselves. Not only does Trade allow us access to those things we cannot do for ourselves, but it also allows for more Efficiency. Efficiency, created by specialization, is the real basis for trade, which creates gains we would not otherwise have. Adam Smith and making pins.

Absolute Advantage Trade occurs when there is advantage to do so. To see if there is advantage, we can compare the Production Possibilities Curves for two people, states, or even countries, to see who does what better. Absolute Advantage is about who can make more. – In this example, Country A has the absolute advantage in making Olives, and Country B has the absolute advantage in making Oranges.

Comparative Advantage Comparative advantage is about who can make it more efficiently and about the opportunity costs of making one item over another. Comparative advantage should not be confused with absolute advantage, because even though a country may have an absolute advantage in making something, the opportunity costs may be higher. – In the example below, Country B has the Absolute advantage in both oranges and olives. – The trade off is 20/15 or 4/3 Oranges to Olives for Country B, and for Country A the trade off is 10/5 or 2/1. So, to get one Orange, A trades.5 Olive, and Country B trades.75 Olive. – In this case, Country A has the Comparative Advantage in oranges, and Country B has the Comparative Advantage in Olives.

Comparative Advantage and Trade Using the information from these examples, it would be beneficial for these two countries to specialize and trade. If each country were to split it’s production 50/50 for both olives and oranges, A would produce 5 Oranges and 2.5 Olives, and B would produce 10 Oranges and 7.5 Olives for a total of 15 Oranges and 10 Olives. If each country were to specialize in that which they have Comparative Advantage, A would produce 10 Oranges, and B could produce 6 Oranges and 10.5 Olives, for a total of 16 Oranges and 10.5 Olives.

AP Testing Free Response questions have multiple parts, and require you to explain your answers. – A. Does this countries PPC exhibit increasing opportunity costs? Explain – B. If this country were to go to war, the most likely move would be from point C to which point? Explain – C. If the country entered into a recession, the country would move from point C to what point? Explain – Total 6 points A B C D E F Guns Butter