1. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 1 of 40 Unit I: Basic Economic Concepts Topic E: Overview of comparative advantage, absolute advantage, specialization, and exchange

2. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 2 of 40 Scarcity and Choice in a One-Person Economy Nearly all the basic decisions that characterize complex economies must also be made in a single- person economy. Constrained choice and scarcity are the basic concepts that apply to every society.

3. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 3 of 40 Scarcity and Choice in a One-Person Economy Opportunity cost is that which we give up or forgo, when we make a decision or a choice.

4. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 4 of 40 Scarcity and Choice in an Economy of Two or More A producer has an absolute advantage over another in the production of a good or service if it can produce that product using fewer resources.

5. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 5 of 40 Scarcity and Choice in an Economy of Two or More A producer has a comparative advantage in the production of a good or service over another if it can produce that product at a lower opportunity cost.

6. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 6 of 40 Comparative Advantage and the Gains From Trade Colleen has an absolute advantage in the production of both wood and food because she can produce more of both goods using fewer resources than Bill. Daily Production Wood (logs) Food (bushels) Colleen10 Bill48

7. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 7 of 40 Comparative Advantage and the Gains From Trade In terms of wood: For Bill, the opportunity cost of 8 bushels of food is 4 logs. For Colleen, the opportunity cost of 8 bushels of food is 8 logs. In terms of food: For Colleen, the opportunity cost of 10 logs is 10 bushels of food. For Bill, the opportunity cost of 10 logs is 20 bushels of food. Daily Production Wood (logs) Food (bushels) Colleen10 Bill48

8. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 8 of 40 Comparative Advantage and the Gains From Trade Suppose that Colleen and Bill each wanted equal numbers of logs and bushels of food. In a 30-day month they (each separately) could produce: Daily Production Wood (logs) Food (bushels) Colleen10 Bill48 Monthly Production with No Trade Wood (logs) Food (bushels) Colleen150 Bill80 Total230 A. B.

9. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 9 of 40 Comparative Advantage and the Gains From Trade By specializing on the basis of comparative advantage, Colleen and Bill can produce more of both goods. Monthly Production after Specialization Wood (logs) Food (bushels) Colleen27030 Bill0240 Total270 C. Monthly Production with No Trade Wood (logs) Food (bushels) Colleen150 Bill80 Total230 B.

10. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 10 of 40 Comparative Advantage and the Gains From Trade To end up with equal amounts of wood and food after trade, Colleen could trade 100 logs for 140 bushels of food. Then: Monthly Production after Specialization Wood (logs) Food (bushels) Colleen27030 Bill0240 Total270 D. Monthly Use After Trade Wood (logs) Food (bushels) Colleen170 Bill100 Total270 C.

11. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 11 of 40 Specialization, Exchange and Comparative Advantage According to the theory of competitive advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers.