1.4 Comparative Advantage and Trade

• Absolute advantage refers to the ability of an entity to produce more of a good or service than another entity using the same amount of resources
• If Country A can produce 100 units of wheat with the same resources that Country B uses to produce 80 units, Country A has an absolute advantage in wheat production.
• Comparative advantage refers to the ability of an entity to produce a good or service at a lower opportunity cost
• What is the formula to calculate the opportunity cost of producing good X?

  \frac{\text{Amount of Y given up}}{\text{Amount of X produced}}</latex>
• Absolute advantage is determined by quantity of output, while comparative advantage is determined by opportunity cost.
• Opportunity cost is the value of what is given up when choosing one alternative over another
• What is the formula to calculate opportunity cost?

  $\frac{\text{Value of what is given up}}{\text{Value of what is gained}}$
• If attending a college class costs $50 in tuition and $45 in lost income, the opportunity cost of attending the class is $95.
• Gains from trade refer to the economic benefits derived from engaging in international or domestic trade
• Steps of how gains from trade are achieved

  1️⃣ Specialization

  2️⃣ Efficiency

  3️⃣ Wider Choice

  4️⃣ Lower Prices

  5️⃣ Economic Growth
• If Country A specializes in wheat and Country B in textiles, they can both enjoy more of both goods at lower costs through trade.
• Comparative advantage refers to the ability to produce a good or service at a lower opportunity cost
• What is the formula to calculate opportunity cost for comparative advantage?

  $\frac{\text{Amount of Y to give up}}{\text{Amount of X produced}}$
• If Country A and Country B have the same opportunity costs for producing wheat and cars, neither has a comparative advantage.
• Specialization is one of the key reasons for gains from trade
• Benefits of trade from specialization

  1️⃣ Wider Choice

  2️⃣ Lower Prices

  3️⃣ Economic Growth
• The comparative advantage theory assumes no transport costs or economies of scale.
• What is one limitation of the comparative advantage theory regarding income inequality?

  Trade benefits may not be even
• Real-world applications of comparative advantage include international trade agreements
• The comparative advantage theory may lead to unequal income distribution and environmental degradation.