Chapter 1--Comparative Advantage and the Benefits of Trade Flashcards
What is an opportunity cost for a given activity?
What you give up to be able to take part in that activity
Among a group of individuals, companies, or countries, how do we decide who has comparative advantage for a given activity?
That entity that has the lowest opportunity cost relative to those with whom it is compared
Since comparative advantage is real, what should individuals, companies, and countries do to provide mutual advantage?
Specialize in things for which their comparative advantage is high, and trade in things where it is not
What are the factors of production? What do they encompass? Why are they scarce resources?
Land, labor, capital, and entrepreneurial ability
These encompass all the possible productive resources to produce goods and services, and all are scarce (i.e.: limited in supply)
What is the factor of production called “Land”? What is its unit price on the market?
All natural resources used to produce goods and services
Rent
What is the factor of production called “Labor”? What is its unit price on the market?
Work time and work effort that people devote to producing goods and services
Wage
What is the factor of production called “Capital”? What is its unit price on the market?
All tools, instruments, machines, buildings, and other constructions that have been produced in the past that businesses now use to produce goods and services
Interest
What is the factor of production called “Entrepreneurial Ability”? What is the income earned or lost by entrepreneurial ability?
All human resources that organize the other factors of production
Profit
What is the primary way factors of production are allocated under capitalism?
By the price mechanism
What is a production possibilities frontier? What concept is it based upon?
A model of an economy that shows how much the economy can produce using all of its factors of production efficiently
Opportunity Cost
What is the Law of Increasing Opportunity Cost? Why does it occur?
As we move along the Production Possibilities Frontier at a standard rate (i.e.: 3 units along the x axis), the opportunity cost (measures along the y axis) will increase as we get closer to y = 0
It occurs because initial increases along the x axis are obtained using the best factors of production. As we get further down x, best factors have been used up, and all that is left are poorer factors that, therefore, require more factors from the y-axis activity to be diverted.
What is an Absolute Advantage in an activity?
To have the lowest absolute production cost for that activity relative to others with whom you are compared
What is the difference between Absolute Advantage and Comparative Advantage?
Absolute Advantage is based on having the lowest absolute production cost
Comparative Advantage is based on having the lowest opportunity cost
How is Absolute Advantage in an activity determined?
By identifying which entity can produce the most of a good or service if all efforts are devoted to that activity, all else being equal
How is a Comparative Advantage in an activity determined?
By identifying which entity can produce a good or service at the lower opportunity cost, all else being equal
