Lecture Outline – Comparative Advantage and Trade1. Introduction• Explain how trade makes people better off when their preferences (i.e. tastes) differ.o Trade occurs whenever two entities (people, business, households, countries, etc.) engage in a mutually beneficial changeo They trade things that have no value to them, for something that they want/need. Then the person that they traded with can do something with the thing they got (selling old books to a bookstore)o Each entity puts a different value on the books• Explain how trade increases productivity through specialization and the division of knowledge.o Trade allows someone to specialize and perfect one thing, rather than try to produce everything they might needo Trade increases productivity by increasing availability of knowledge, and knowledge increases productivityo Ex: farmers know more about farming and can invest in large-scale machines that are more productive. Knowledge spread out among many brains that makes us benefit more2. A Model of Scarcity, Tradeoffs, and Opportunity Costs – The Production Possibilities Frontier (PPF); sometimes called the Production Possibilities Curve (PPC)o The problem that economics focuses on is scarcity (desirable and limited). Hu-mans wants and needs are infinite, but the resources needed to meet those wants are limited and scarceo Opportunity cost is the opportunity lost· What assumptions are used to draw a PPF?o Production Possibility Curve: a basic economic model which shows the trade-offs society or an individual faces in how to use scarce resourcesa line from one axis to another based on what is possibleo Different combinations of two tradeoffs (ex: amount of work and play during the day)o To find the opportunity cost of a PPF, you find the max of each axis’ benefit, and then divide by whichever one you want to see the opportunity cost of (see video 3)· Explain the following:o Why is it impossible to attain a point outside of the PPF? Desirable but not possible because there's not enough resources be-tween the two competing thingso Why is a point inside of the PPF labeled “inefficient?” Possible, but undesirable They would have extra resources because it’s not being put to produc-tive use· Use the PPF to identify the opportunity cost of the good listed on the x-axis.o Benefit or enjoyment from play· Use the PPF to identify the opportunity cost of the good listed on the y-axis.o 4 hours of work/pay if you move from 16 hours to 123. The Theory of Comparative Advantage· Define and differentiate between absolute advantage and comparative advantageo Comparative advantage: one thing has a lower OC for producing a certain goodo Absolute Advantage: one country can use all of its resources to produce more of a good than another country· Two trading entities (i.e. individual, countries) can benefit if they specialize and trade according to their comparative advantage. Explain.o They both gain from the trade. They won’t accept anything less than what they produce, or else it is pointless· If we assume that both countries specialize according to their comparative advantage, then how do we find a terms of trade that will cause both entities (i.e. individuals, countries) to be better off?· Explain why comparative advantage – not absolute advantage – is the basis for trade. Support your answer with an example that shows that a rich entity and a poor entity can both benefit by trading with each other.o By using a comparative advantage for the basis of trade, both countries can specialize in the production of one of the goods because there will be a lower opportunity