1 Comparative Advantage

Question 1

model

Answer 1

a simplified representation of reality

Question 2

Production Possibility Curve (PPC)

Answer 2

shows the different combinations of two goods that can be produced using full employment resources -captures all maximum output possibilities for two or more goods,given a set of inputs or resources when they are used efficiently

Question 3

Consumption Possibility Curve (CPC)

Answer 3

represents all possible combinations of two goods that the agents in an economy can consume.

Question 4

Absolute Advantage

Answer 4

An agent has an absolute advantage when he can carry on this activity with fewer resources than another agent.

Question 5

Opportunity Cost

Answer 5

The Opportunity Cost of a given action is the value of the next best alternative to that particular action. (OC= slope of the PPC)

Question 6

Comparative Advantage

Answer 6

An agent has a comparative advantage when he can carry on this activity with lower opportunity cost than another agent.

Question 7

Principle of Comparative Advantage

Answer 7

Everyone is better off if each agent specialises in the activities for which they have a comparative advantage.
The gain from the specialisation grow larger as the difference in opportunity cost increases.

Question 8

Principle of Increasing Opportunity Cost:

Answer 8

In the process of increasing the production of any good, first employ those resources with the lowest opportunity cost and only once these are exhausted turn to resources with higher cost.

Question 9

The Low-Hanging Fruit Principle (or Increasing Opportunity Cost)

Answer 9

The Low-Hanging Fruit Principle (or Increasing Opportunity Cost) states that in the process of increasing the production of any good, one first employs those resources with the lowest opportunity cost and only once these are exhausted turn to resources with higher cost.

• in order to increase the quantity of the product, we gradually allocate the task to agents with higher and higher opportunity costs.

Question 10

Consumption Possibility Curve (CPC)

Answer 10

The CPC represents all possible combinations of bananas and rabbits that the economy can feasibly consume when it is open to international trade

• Tangent of PPC

Question 11

The relationship between PPC and CPC:

Answer 11

1. If a country is a closed economy (doesn’t trade internationally), the PPC and the CPC are the same because the agents must consume whatever they produce.
2. If a country is an open economy (trades on the international market), the CPC is usually greater than the PPC because part of what the agents produce can be traded for other goods and services, which relieves the restrictions on consumption

Question 12

Classic Critiques to the Model:

Answer 12

• psychological costs of being productive the whole day
• assume that transaction costs connected with trading, not representative of the real life
• sunk cost for a country
• the change in socio-economic environment