Global Economy Notes– PART 1 : Why Nations Trade
Absolute advantage:
Comparative advantage:
•
Natural resources, human capital, and physical capital are unevenly distributed from country to
country. Because countries ________________ so much in resources, they also differ in their
ability to produce different goods and services. They will ___________________ in certain
products that they can produce most efficiently.
•
For example, coffee is grown more efficiently in warm areas like Central America than in other
parts of the world. Because countries cannot efficiently produce everything their citizens need and
want, they engage in trade.
•
A person or nation has _______________________________ when it can produce more of a given
product using a given amount of resources.
•
For example, suppose that two of your friends, Ricky Bobby and Dorothy Ann, want to make
some extra money. They decide to print designs on T-shirts and make birdhouses.
T-Shirts per hour
Birdhouses per hour
Dorothy Ann
Ricky Bobby
•
As shown in the chart, Dorothy Ann can either print six T-shirts per hour or make two birdhouses per
hour. Ricky Bobby can print one T-shirt or make one birdhouse per hour.
•
In other words, Dorothy Ann is more __________________________ than Ricky Bobby in making both Tshirts and birdhouses.
•
In economic terms, Dorothy Ann has an _____________________ advantage over Ricky Bobby in
producing both goods.
•
Suppose that each person is initially self-sufficient, they produce their own goods.
•
Because Dorothy Ann enjoys absolute advantage in both goods, should she remain self-sufficient?
•
Would she be better off if she specialized in either T-shirts or birdhouses?
•
What should Ricky Bobby produce – T-shirts, birdhouse, or both?
Countries have to face the same sorts of questions as individuals. Should a wealthy nation with many
resources be self-sufficient, or should it specialize in a few products and trade for the goods it doesn’t
produce?
•
_____________________________________________ is the ability of one person or nation to
produce a good at a lower opportunity cost than that of another person or nation.
•
__________________________ – the most desirable alternative given up as the result of a decision.
•
For example, suppose you have to choose between time with your wife or time enjoying life. The
opportunity cost of extra time with your wife is less enjoyment of life. The opportunity cost of an
enjoyable life is less time with your wife.
•
The ________________________________________________ states that nations are better off
when they produce goods and services they have a comparative advantage in supplying. The
money nations make from selling those goods and services can be used to buy the goods and
services they cannot produce as efficiently.
•
To determine comparative advantage in the example involving Ricky Bobby and Dorothy Ann,
you need to look at the _______________________ costs of producing T-shirts and birdhouses.
•
DA’s opportunity costs: In an hour, DA can make either six T-shirts or two birdhouses. She
therefore sacrifices three T-shirts fro every birdhouse she produces. In other words, the
opportunity cost of a birdhouse is the three T-shirts she could have produced instead.
Conversely, the opportunity cost of a T-shirt is one-third of a birdhouse.
Opportunity Cost of a T-shirt
Opportunity Cost of a birdhouse
Dorothy Ann
birdhouse
T-shirts
Ricky Bobby
birdhouse
T-shirt
•
RBs opportunity costs: RB sacrifices only one T-shirt for every birdhouse. His opportunity
cost for a birdhouse is the one T-shirt that he could have produced instead.
Each person should produce the good for which he or she has a _______________________ advantagethat is, a ___________________ opportunity cost than the other person.
•
Why is it sensible for Ricky Bobby to specialize in birdhouses?
Benefits from Specialization and Trade for Ricky Bobby and Dorothy Ann
Ricky Bobby
Specialization
RB specializes,
switching 2
hours from Tshirt production
to birdhouse
production.
Dorothy Ann
Trade
Gain from
Specialization
Specialization
Trade
Gain from
Specialization
RB trades 1
birdhouse
for 2 Tshirts
Gain is the
same number of
T-shirts plus 1
more birdhouse
DA specializes,
switching one
half-hour from
birdhouse
production to Tshirt production.
DA trades 2
T-shirts for 1
birdhouse.
Gain is the
same number of
birdhouses and
1 more T-shirt.
• __________________ distribution of resources among nations
leads countries to ________________ in products that require the
use of their available resources. Countries may then
________________ with other countries for the products that
they cannot produce.
• Comparative advantage : lower________________________ :
: absolute advantage : more ________________________ .