Absolute and Comparative Advantage, Specialization, and Gains from Trade

All flashcards

Absolute advantage

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

Comparative advantage

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

Opportunity cost

The value of the next-best alternative forgone when resources are used for a particular purpose.

Specialization

Shifting resources toward producing goods in which a country has comparative advantage.

Mutually beneficial terms of trade

Exchange terms between trading partners' opportunity costs that can benefit both sides.

Quiz questions

1. What determines whether a country has a comparative advantage in producing a good?Answer: It produces the good at a lower opportunity cost than another country.
2. The United States gives up 1/2 barrel of oil to produce a bushel of corn, while Saudi Arabia gives up 4 barrels. Which country has a comparative advantage in corn?Answer: The United States, because its opportunity cost is lower.
3. Saudi Arabia gives up 1/4 bushel of corn per barrel of oil, while the United States gives up 2 bushels. Which exchange rate for one barrel of oil could benefit both countries?Answer: One barrel of oil for 1 bushel of corn.
4. Before specialization, two countries together produce 80 barrels of oil and 70 bushels of corn. If specialization raises their combined output to 100 barrels of oil and 100 bushels of corn, what has happened?Answer: Combined output of both goods has increased.
5. What assumption about opportunity costs produces a straight-line production possibility frontier?Answer: Opportunity costs remain constant as production shifts between goods.