Specialization and Trade Benefits

Specialization and Trade Benefits

• Specialization and trade allows individuals to consume beyond their production possibilities frontier (PPF).
• Specialization increases resource use efficiency leading to greater overall production.
• Markets enable the exchange for goods that individuals do not produce themselves.

Absolute Advantage

• Absolute advantage is the ability to produce a good using fewer resources compared to another producer.
• Absolute advantage does not always dictate specialization due to individuals often having the advantage in multiple areas.
• Adam Smith advocated specializing in goods with an absolute advantage.

Comparative Advantage

• Comparative advantage stems from producing a good at a lower opportunity cost than others.
• David Ricardo argued individuals and nations should specialize in products with the lowest opportunity cost.
• The Ricardian Trade Model suggests specialization and trade lead to higher production.
• Government intervention reduces trade gains by creating market inefficiencies.
• Comparative advantage looks at opportunity costs rather than absolute productivity.

Opportunity Cost

• Opportunity cost is the value of the next best alternative when making a decision.
• Opportunity cost is calculated by comparing how much of one good must be sacrificed to produce another.
• Trade enables consumption beyond what autarky allows by focusing on comparative advantage and opportunity cost.

Autarky

• Autarky is a state of self-sufficiency where individuals or nations do not engage in trade.
• Autarky limits consumption to what can be produced.

Ricardian Trade Model

• The Ricardian Trade Model assumes two people produce two products using one input.
• The Ricardian Trade Model suggests governments should follow a laissez-faire policy.

Markets

• Markets reallocate goods, services, and resources from low-value users to higher-value users.
• A market reaches equilibrium when the quantity supplied equals the quantity demanded
• Specialization and trade enable consumption beyond what is possible under autarky and this is illustrated to the production possibilities frontier (PPF).

Supply and Demand

• As the price of a good rises, the quantity supplied also rises.
• The demand curve represents the willingness to pay for a good at different price levels.
• When a firm notices an increasing unsold goods inventory, the price will likely decrease.

Elasticity

• Elasticity measures the sensitivity of one variable to changes in another.
• If the price elasticity of demand is -2.5, demand is considered elastic.
• When demand is price-inelastic, a firm can raise its price, and total revenue increases.
• Demand tends to be more price-elastic when the good is a luxury.
• Cross-price elasticity measures how the quantity demanded of one good responds to changes in the price of another good.
• If two goods are substitutes, their cross-price elasticity is positive.
• If two goods are complements, their cross-price elasticity is negative.
• Income elasticity of demand for luxury goods is typically greater than 1.
• Price elasticity indicates the impact of price changes on total revenue.

Inferior vs Normal Goods

• Normal goods see an increase in demand as consumer income rises, while inferior goods see a decrease.
• Decrease in price for substitutes lowers demand.
• Technological advances shift supply curves to the right.

Government Intervention

• Internet regulations raising costs for movie rental companies shifts the supply curve to the left, while raising equilibrium price and lowering quantity.
• Firms facing highly elastic demand should reduce prices to attract more customers.

Consumer and Producer Surplus

• Consumer surplus is the difference between a buyer's willingness to pay and the actual price paid.
• Producer surplus is the difference between what sellers are willing to accept and the market price.
• Total surplus is the sum of consumer and producer surplus

Taxes

• Taxes reduce total surplus and leads to deadweight loss.
• When demand is inelastic, a tax results in high government revenue .
• The tax amount is split between seller and buyer

Price Ceilings and Floors

• Price ceilings prevent prices from rising too high and leads to shortages.
• Price floors are a legally established minimum price that must be paid for a good or service, often resulting in a market surplus.
• Price controls often result in deadweight loss and inefficiency.