AP Macroeconomics Module 4: Comparative Advantage and Trade

comparative advantage

An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good or service is lower than that individual than for other people. ex: The opportunity cost for Alex to catch a fish is 3/4 of a coconut, while the opportunity cost for Kirk to catch a fish is 2 coconuts. Alex has the comparative advantage in catching fish.

absolute advantage

An individual has an absolute advantage in producing a good or service if he or she can make more of it with a given amount of time and resources. Having an absolute advantage is not the same thing as having a comparative advantage. Ex: Alex can catch more fish and more coconuts in a week than kirk, so he has an absolute advantage in both activities.

While one might have the absolute advantage in production over another, why can cooperation still benefit this individual?

Comparative advantage, not absolute advantage, is the basis for mutual gain.

When is the most optimal time for two parties to exchange goods?

If the price of the good each person obtains from trade is less than his own opportunity cost of producing the good.

trade

In a market economy, individuals engage in trade: they provide goods and services to others and receive goods and services in return.

What is the range of mutually beneficial terms of trade for a product?

The difference between the opportunity cost of the product's producer and the product's buyer. ex: Kirk's opportunity cost to gather a coconut is 1/2 fish per coconut, and Alex's opportunity cost is 4/3 fish per coconut. So any terms of trade between 1/2 fish per coconut and 4/3 fish per coconut would benefit both parties.

terms of trade

The terms of trade indicate the rate at which one good can be exchanged for another. ex: 1 coconut for 1 fish

Why do we have an economy rather than self-sufficient individuals?

There are gains from trade.

Specialization

each person specializes in the task that he or she is good at performing

Gains from trade

people can get more of what they want through trade than they could if they tried to be self-sufficient. This increase in output is due to specialization