Reading notes--Principles of Economics (chapter3)

Summary

Chapter 3 is Interdependence and the Gains from Trade. This chapter explains one principle of Economics–Trade can make everyone better off. In order to explain it, I need to introduce three definitions first.

• Absolute advantage– the ability to produce a good using fewer inputs than another producer
• Comparative advantage– the ability to produce a good at a lower opportunity cost than another producer
• Opportunity cost– whatever must be given up to obtain some item

• This diagram means China could produce 80 iron ore or 100 cars.
• Australia could produce 70 iron ore or 50 cars.

As the diagram shows, China can produce both more iron ore and cars than Aus. That means China has absolute advantage in producing both goods. However, according to the definition of opportunity cost, the opportunity cost for China to produce an iron ore is 1.25 cars. (Because producing 80 iron core needs to abandon 100 cars). And the opportunity cost for Australia to produce 1 iron core is just 0.71 car. In other words, Australia has the comparative advantage in producing iron core.

This is the key to explain why trade can make everyone better off. Trade can make everyone in the economy produce goods with the lowest opportunity cost.

Definitions

1. Absolute advantage– the ability to produce a good using fewer inputs than another producer

2. Opportunity cost– whatever must be given up to obtain some item

3. Comparative advantage– the ability to produce a good at a lower opportunity cost than another producer

4. Imports– goods produced abroad and sold domestically

5. Exports– goods produced domestically and sold abroad

Review

I did all questions correctly! Excellent!