Comparative Advantage, Specialization, and Gains from Trade

All flashcards

What is absolute advantage?

The ability to produce more of a good with the same resources, or the same amount with fewer resources, than another producer.

What is comparative advantage?

The ability to produce a good at a lower opportunity cost than another producer.

How are absolute and comparative advantage different?

Absolute advantage concerns productivity and resource use. Comparative advantage concerns what must be given up, or opportunity cost.

The United States uses 4 workers for 1,000 pairs of shoes and 1 for 1,000 refrigerators; Mexico uses 5 and 4, respectively. Which country has comparative advantage in each good?

The United States has comparative advantage in refrigerators, while Mexico has comparative advantage in shoes.

How can trade benefit a country that is less productive in every good?

It can specialize in goods with relatively lower opportunity costs and trade for goods that are more costly for it to produce.

Quiz questions

1. What does absolute advantage compare?Answer: Output relative to the resources used to produce a good.
2. What does a country's production possibility frontier show?Answer: Combinations of goods producible with available resources and technology.
3. One Canadian worker can produce 20 barrels of oil or 40 tons of lumber. What is the opportunity cost of producing one barrel of oil?Answer: 2 tons of lumber.
4. For both countries to gain from trade, what must be true of the terms of trade?Answer: They must fall within a range acceptable given both countries' opportunity costs.
5. One Canadian worker can produce 20 barrels of oil or 40 tons of lumber. One Venezuelan worker can produce 60 barrels of oil or 30 tons of lumber. Which country has comparative advantage in oil?Answer: Venezuela, because its opportunity cost of oil is lower.