Gains From Trade

Abstract

There are two individuals, A and B, who can produce two goods, 1 and 2. The production-possibility frontiers of both individuals are $x_{1}^{A}=a-b\,\cdot\,x_{2}^{A}$ and $x_{1}^{B}=c-d\,\cdot\,x_{2}^{B}$, in which a,b,c and d are strictly larger than zero.

• 1. If b > d, then A has a comparative advantage in the production of good 1.

• 2. If a > c, then A has an absolute advantage in the production of both goods.

• 3. If a = c, then no individual has a comparative advantage.

• 4. If a = 100 and b = 2, then A can produce 50 units of the second good at maximum.

• 1. A situation in which there is no trade between countries is defined as “autarky.”

• 2. The theory of comparative advantage is only valid for linear production-possibility frontiers.

• 3. If a country has a comparative disadvantage in the production of a good, it should not trade this good with other countries.

• 4. All countries always benefit from specialization and trade.

Charlotte and Phil are both bakers. Charlotte can either bake 20 cakes, 15 pizzas or any linear combination of the two in one day. Phil can either bake 10 cakes, 5 pizzas or any linear combination of the two in one day.

• 1. Charlotte has a comparative advantage in baking pizza.

• 2. Charlotte has an absolute advantage in baking pizza.

• 3. Phil’s opportunity costs for a pizza are equivalent to two cakes.

• 4. Charlotte’s opportunity costs for cake are lower than Phil’s.