Topic 1-Comparative Advantage And The Basis For Trade

Question 1

Production Possibility Curve

Answer 1

Represents all possible combinations of 2 goods that can be produced with an individual’s labour if he works all the available hours

Question 2

Production Possibility Frontier

Answer 2

Captures all maximum output possibilities for two (or more) goods, given a set of inputs (or resources) if inputs are used efficiently

Question 3

PPC Assumptions

Answer 3

1) only 2 possible activities
2) only 2 individuals

3) when trading there are
a) no transaction costs (negotiation/transportation costs)

b) no other barriers (import quotas, tariffs)

Question 4

Efficient production point

Answer 4

Represents a combination of goods for which currently available resources DO NOT ALLOW an increase in the production of one good without a reduction in the production of another.
All points on the PPC are efficient

Question 5

Inefficient production point

Answer 5

Respects a combination of goods for which currently available resources allow an increase in the production of one good without a reduction in the production of the other.
All points below and to the left of the PPC are inefficient

Question 6

Attainable production point

Answer 6

Represents any combination of goods that can be produced with the currently available resources.
All points on the PPC or below and to the left of the PPC are attainable

Question 7

Unattainable Production point

Answer 7

Represents any combination of goods that can not be produced with the currently available resources.
All the points that lie outside of the PPC are unattainable

Question 8

Absolute Advantage

Answer 8

An agent/economy has an absolute advantage in a productive activity when he/she can carry on this activity with less resources than another agent

Question 9

Opportunity cost

Answer 9

Opportunity cost of a given action is the value of the next best alternative

e.g.
OC bananas = loss in rabbit/gain in bananas
OC rabbit = loss in bananas/gain in rabbit

Question 10

Comparative advantage

Answer 10

An agent/economy has a comparative advantage in a productive activity when he/she has a lower opportunity cost of carrying this activity than another agent

Question 11

Principle of comparative advantage

Answer 11

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

Question 12

Principle of increasing opportunity cost

Answer 12

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 then to resources with higher cost

Question 13

Economic growth and the factors that drive it

Answer 13

Economic growth is when the economy PPC is pushed out and to the right

Factors that drive this are:
1) increase in infrastructure

2) increase in population of labour force
3) advancements in knowledge and technology such as education, R&D, IT, communications tech

Question 14

Consumption possibility curve

Answer 14

Represents all possibly combinations of two goods that the agents in an economy can feasibly consume when it is open to international trade

Question 15

What are closed and open economies and their effects on the PPC and CPC

Answer 15

Closed economy is when there is no trade - PPC and CPC are identical

Open economy is when there is trade on the international market - CPC is to the right and above the PPC

Consumption possibilities in an open economy are always larger than in a closed one which is why economists generally like free trade

Question 16

Critiques to the PPC model

Answer 16

1) no psychological cost associated to performing the same activity the entire day
2) no transaction cost connected with trading
3) no import quotas or tariffs would limit the gains from specialisation by making specialisation (beyond a certain level) pointless
4) no change in preferences for goods/services in which a country specialises in and no accounting for social norms that might prevent trading