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MODULE 1.4 COMPARATIVE ADVANTAGE AND TRADE This module introduces the concepts of comparative and absolute advantage, and explains the benefits of specialization and trade. It shows how the PPC model can be used to illustrate gains from trade based on comparative advantage. Finally, the basic economic argument in favor of international trade is explained by showing that total world output can increase when countries specialize and trade. Learning Objectives Place a " " on the line when you can do each of the following: Objective #1. Explain how trade leads to gains for an individual or an economy Objective #2. Explain the difference between absolute advantage and comparative advantage Objective #3. Describe how comparative advantage leads to gains from trade in the global marketplace Guided Reading Fill in the blanks to complete the following statements. When people divide tasks so that each person provides a good or service that other people want in return for different goods and services that he or she wants, it is called 1) . Central to a better standard of living for everyone because it allows for the division of tasks based on what each person is better at producing, it is called 2) If the opportunity cost of production is lower for one person or country than it is for other people or countries, then that person or country has a(n) 3) advantage. If an individual or country can produce more output with a given amount of input than another person or country, then that person or country has a(n) 4) advantage. advantage is the basis for mutual gains from trade. In an example in which 5)_ two countries can each produce the same two goods, it is possible for a country to have a(n) advantage in both goods, but it is not possible for a country to have a(n) 7) 6) advantage in both goods. 14 Module 1.4: Comparative Advantage and TradeKey Terms Define each of the following terms: Trade Specialization Comparative advantage Absolute advantage Terms of trade bead Charhasing Gains from trade Practice the Model Use the data from the following table to construct a correctly labeled graph showing the production possibilities curves for Portugal and the United States. Assume that both countries have constant opportunity costs. Use the information on the table and your graph to fill in the blanks: Olive oil Textiles United States 20 30 Portugal 50 50 1. The opportunity cost of 1 unit of textiles in the United States is and in Portugal is 2. The opportunity cost of 1 unit of wine in the United States is and in Portugal is 3. Assuming the two countries have identical resources, the United States has an absolute advantage in Portugal has an absolute advantage in 4. The United States has a comparative advantage in Portugal has a comparative advantage in Unit 1 | Basic Economic Concepts 15Fill in the following table. Assume that with trade, each country specializes and exports 1/2 of its production. Also assume that the terms of trade are I wine for 2 textiles. Without Trade With Trade With Trade Production Consumption) xtiles Wine Textiles Wine Textiles Portugal United States Total What happens to total world output when the countries specialize and trade? Check Your Understanding Circle the best choice to answer the question. Use the following information to answer questions 1-3. Two countries, Texia and Urbania, produce food and clothing, and currently do not trade. Both have linear PPCs. Texia can produce 1,000 units of food and 0 units of clothing or 500 clothing and 0 food. Urbania can produce 900 units of food and 0 units of clothing or 300 clothing and 0 food. 1 . has the absolute advantage in clothing, and has the absolute advantage in food. a. Texia; Texia b. Texia; Urbania c. Urbania; Texia d. Urbania; Urbania e . Neither country, neither country 2. has the comparative advantage in clothing, and has the comparative advantage in food. a. Texia; Texia b. Texia; Urbania c. Urbania; Texia d. Urbania; Urbania e. Neither country, neither country 3. Specialization and trade benefit usually only one of the trading partners. b. the wealthier country more than the poorer country. c. the poorer country more than the wealthier country. d. both countries if they specialize according to their respective comparative advantages. e. neither country when one country is better at producing both goods.Practice the Skills Use the information on the graphs to fill in the blanks. Portugal United States Textiles Textiles 100 90 Production without trade 50 Production without trade 30 4 20 30 Wine 50 100 Wine 1. a . The opportunity cost of 1 unit of textiles in the United States is and in Portugal is b. The opportunity cost of 1 unit of wine in the United States is and in Portugal is c. Assuming the two countries have identical resources, the United States has an absolute advantage in Portugal has an absolute advantage in d. The United States has a comparative advantage in Portugal has a comparative advantage in Fill in the following table. Assume that with trade, each country specializes and exports 1/2 of its production. Also assume that the terms of trade are 1 wine for 2 textiles. With Trade With Trade Without Trade Production) Consumption Wine Textiles Wine Textiles Wine Textiles Portugal United States Total 2. What happens to total world output when the countries specialize and trade? Unit 1 | Basic Economic Concepts 17MODULE 1.5 COST-BENEFIT ANALYSIS This module examines how individual decision-makers use appropriate measures of costs and benefits to make economic decisions. Learning Objectives Place a " " on the line when you can do each of the following: Objective #1. Calculate opportunity costs associated with choices Objective #2. Explain a decision by calculating and comparing total benefits and total costs. Objective #3. Explain a decision using marginal analysis Guided Reading Fill in the blanks to complete the following statements. When consumers and producers make decisions that incorporate their opportunity costs, they are acting as 1) 2) measures personal satisfaction. Firms seek to maximize 3) and 4) Consumers and firms both seek to maximize the difference between their 5) and their 6) This process is known as 7) The additional benefit from consuming or producing an additional unit of a good is called 8) The additional cost associated with consuming or producing another unit of a good is 9) A 10) has already been incurred and cannot be recovered. Unit 1 | Basic Economic Concepts 19