ECON 162 9 16 15 The Principle of Comparative Advantage Each party to a trade should specialize in the production of that good in which it is relatively more efficient or where it had a lower opportunity cost Corollary Mutual gains arise from specialization and trade Absolute Advantage Lower resource cost Comparative Advantage Lower opportunity cost Ex 1 United States Mexico Absolute Advantage Computers 1 year Beer 1 year 4 2 Determine Opportunity Costs United States Mexico 1 3 Mexico 1C 3B 1C 3B 1B 1 3C United States 4C 2B 1C 1 2B 1B 2C United States has a lower opportunity cost in computers 1 2B vs 3B therefor they should specialize in computers Mexico has a lower opportunity cost in beer 1 3C vs 2C therefor they should specialize in beer Terms of Trade The rate at which both parties would be willing to make a trade This value depends on opportunity costs United States is willing to trade 1 computer for anything greater than a beer Mexico is willing to trade 1 beer for anything greater than 1 3 a computer Mexico is willing to accept 1 computer for anything less than 3 beers They are both willing to trade 1 computer for 1 beer
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