3.1 A2 HL Comparative Advantage and Trade

What determines greater efficiency or lower costs? Costs of production varies between countries because of “factor endowments” – types of factors of production a country is “gifted” with. Task: Think of a country’s 2 or 3 major exports Research the relevant factor endowments

u Imagine...  only two goods: potatoes and meat  only two people: Mr. Jones and a Mrs. Choi u Should they each produce for their own needs or should they trade? A Parable for comparative advantage

Who is most efficient at each product? Would you think there’s a good reason to trade? The producer that requires a smaller quantity of inputs (in this case, hours of labour) to produce a good is said to have an absolute advantage in producing that good. Does that mean Mrs. Choi has no reason to trade?

Consider Mr. Jone’s Production – and consumption – Possibilities Frontier Potatoes (pounds) Meat (pounds) A

Mrs. Choi’s Production – and consumption – Possibilities Frontier Potatoes (pounds) Meat (pounds) B

Compare the Opportunity Cost for each person producing Meat and Potatoes Who has the comparative advantage for a) meat b) potatoes? The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. 1 lb. of Meat1lb. Of Potatoes Mr. Jones2 lb. potatoes0.5 lb. meat Mrs. Choi1.25 lb. potatoes0.8 lb. meat

The Gains from Trade: Suppose the “terms of trade” is 0.66 Lbs. of meat for 1 Lbs. of Potatoes: using the data below, calculate how much each person has gained. Can you show the new “consumption frontier” after trade (on each PPF) has increased? That’s why it’s good to trade even for Mrs. Choi!

Limitations of the theory To what extent are these assumptions valid? there is perfect knowledge of cheapest products No cost is involved for transportation Only 2 countries that trade costs do not change, there are no EoS The goods traded are identical FoP remain in the country Trade is perfectly free