ECON 1000 Lecture 2

9/19/2014 10:29:00 AM

Comparative Advantage and the gains from trade

A person has comparative advantage in producing a good if she can
produce it at a lower opportunity cost than any one else.
Involve comparing opportunity costs
Three ways
o Labour requirements
Comparative advantage is the source of the gains from trade
David Ricardo 19th century
CA indicates that specialization and free trade will benefit all trading
partners

o Specialization and trade allow consumption at points outside

the PPF
Absolute advantage
o A person or country has absolute advantage in producing one
or more commodities, if, using the same quantity of
resources, she can produce more than anyone else
o Involves production per hour
o Adam Smith -1776
o Does not measure opportunity cost
o Does not explain the pattern of trade
o Ex.
Mexico and Canada produce both oil and apples using
labor only. A barrel of oil can be produced with four
hours of labor in Mexico and eight hours of labor in
Canada.
A bushel of apples can be produced with eight hours of
labor in Mexico and 12 hours of labor in Canada
Mex has the abs. advantage in oil because 4 < 8

Mexico can produce a barrel of oil with less labor than

Canada.
o Does not mean you have comparative advantage
Must form a ratio for this
4/8 for mexico, 8/12 for Canada
Comparative Advantage
Must calculate CA for both products for both countries and see
where each specializes in

Chapter 3: Demand & Supply

Markets and Prices
o Market: place where goods and services are traded
o Competitive market market with mayn buys and sells
o Markets determine prices
o Money price: the number of dollars to buy one unit of a
commodity
o Relative price: the ratio of one price to another
o Relative price reflects opportunity cost (tradeoff)

Determined by demand and supply

Prices influences decisions

Demand
Quantity demanded quantity demanded at a particular price
The Law of Demand
Other things remaining the same, the higher the price of a good,
the smaller is the quantity demanded
Why does a higher price reduces the quantity demand?
Substitution effect
o Dont change the price, but want something else because the
price is too high
Income effect
o We dont only buy one product, but need a multitude of good
and services that we must consider with respect to our
income
o Income can also influence our decisions
Demand Curve and Demand Schedule
Graph that shows the relationship between the price and the
quantity demanded when all other factors remain the same
The demand curve slopes downward
Change in Demand

Changes when other factors besides the price change. This

correspond to a shift in the demand curve
Factors:
o The price of related goods
o Expected future prices
o Income
o Expected future income and credit
o Population higher this is, the more demand
o Preferences develop taste for specific products, everyone
has different tastes
Normal goods
o Things that you buy more of when your income goes up
Inferior goods
o Things that you buy less of when your income goes up

Price of Related Goods

Complements
o E.g. the price for gasoline goes up, the demand for cars goes
down
o goods used together
Tastes and Preferences
Supply

Quantity Supplied
o Amount that producers plan to sell at a particular price
The law of supply
o Other things remaining the same, the higher the price of a
good, the greater the quantity supplied
As prices go up, they can have more product to cover the costs and
make profit
Consumers have budget constraint because of lower income, want
lower price
Supply Curve and Supply Schedule
o A graph that shows the relationship between the quantity
supplied of a good and its price

Changes in Supply
o When other factors besides the price of the product change
o Factors:
The prices of factors of production
The prices of related goods produced
Expected future prices supply will increase in future
The number of suppliers a lot of suppliers, then
increase in supply
Technology imp. Because as it gets better,
productivity increases and supply increases

The state of nature disasters can decrease supply

Market Equilibrium
When the quantity demanded equals the quantity supplied at the
current price
Market moves towards equilibrium
Shortage prices go up
o Occurs when the demand is greater than the supply
Surplus prices go down
o Occurs when the demand is less than the supply

9/19/2014 10:29:00 AM

9/19/2014 10:29:00 AM