People can gain from voluntary trade since these
expand consumption opportunities, expressed by diversity in their opportunity
costs.
3.7 – What´s a Comparative Advantage ? How does it differ from Absolute Advantage ?
Comparative Advantage means differences in opportunity
costs. Thus, a person has a comparative advantage at producing a good if
she can produce it at a lower opportunity cost than other people can.
Absolute Advantage differs from Comparative Advantage
since it means differences in productivity rather than in opportunity costs.
3.8 – Define an Economically Efficient situation and an Economically Inefficient situation.
In an Economically Efficient situation,
there is no way to change it so that everyone gains or so that at least
one gains while no one else loses. In an Economically Inefficient situation,
there is some way to change it that everyone gains or that someone gains
while no one else loses.
3.10 Suppose that Argentina can produce 14 bottles of wine or 40 pounds of beef in one day, while Chile can produce 12 bottles of wine or 30 pounds of beef in one day. Which country has a comparative advantage in wine and which in beef?
Argentina's opportunity cost of producing wine is 40/14 pounds of beef per bottle of wine. Chile's opportunity cost of producing wine is 30/12 pounds of beef per bottle of wine. Because 30/12 < 40/14, Chile has a lower opportunity cost of producing wine than Argentina does, so Chile has a comparative advantage in wine.
Argentina's opportunity cost of producing beef is 14/40 bottles of wine per pound of beef. Chile's opportunity cost of producing beef is 12/30 bottles of wine per pound of beef. Because 14/40 < 12/30, Argentina has a lower opportunity cost of producing beef than Chile does, so Argentina has a comparative advantage in beef.
An alternative way to find comparative advantage is to compare the costs, measured in hours of work, for each country to produce one unit of either good. The following chart shows the time costs of producing each good:
| Time to: | Argentina | Chile |
| Produce one bottle of wine | 1/14 of a day | 1/12 of a day |
| Produce one pound of beef | 1/40 of a day | 1/30 of a day |
3.11 Discuss: "If a situation is economically inefficient, everyone has an incentive to change it."
Whenever a situation is economically efficient, there is a way to change it so that at least one person gains and no one loses. No one would have an incentive to oppose that change because no one would lose, and often everyone could share the gains.
3.12 (on page 56) Use Table 1 from Chapter 1 to
answer these questions:
(a) What is Lisa’s opportunity cost of taking
inventory? What is her opportunity cost of setting up the display?
(b) What is Mitch’s opportunity cost of taking
inventory? What is his opportunity cost of setting up the display?
(c) Who has a comparative advantage in taking
inventory? In setting up the display?
(a) Lisa's opportunity cost of taking inventory
in one section of the store is setting up the display in both sections
of the store. Her opportunity cost of setting up the display in one
section of the store is getting one of the inventories half done.
(b) Mitch's opportunity cost of taking inventory
in one section of the store is setting up 5/6 of one display . His
opportunity cost of setting up the display in one section of the store
is getting 6/5 inventories done.
(c) Lisa has a comparative advantage at setting
up displays, because her opportunity cost of doing that is lower than Mitch's
opportunity cost.
Mitch has a comparative advantage at taking inventories,
because his opportunity cost of doing that is lower than Lisa's opportunity
cost.
3.12 (on page 64) (a) Explain why every economically
efficient situation is technically efficient.
(b) Explain why a situation can be technically
efficient but not economically efficient.
(a) To prove part (a), assume that it is NOT true -- then we will show
a contradiction. So assume that there is an economically efficient
situation that is NOT technically efficient. Since it is not technically
efficient, there is a way to more of at least one good with the same resources.
By providing that good to someone, we can make that person better off without
hurting anyone else -- which contradicts the assumption that the situation
was already economically efficient.
(b) A situation can be technically efficient but not economically efficient
if the economy is producing on its PPF at a point like A in Figure 3 (page
47), but everyone would prefer the combination of goods at point D to the
combination they are getting at point A.
3.14 – In what sense is Economic Efficiency good ?
In the sense that waste is bad. In any economically inefficient situation, a change in the economy can create gains for everyone, or gains for some people without losses for anyone else.
3.16 Explain why there are many economically efficient situations. How do they differ?
Steve and Lauren could make many possible trades, at differing prices.
The chapter discussed two: the first trade, and the second (hor-for-hour)
trade. Each of the situations resulting from these trades is economically
efficient. However, Lauren is better off in one situation,
and Steve is better off in the other. In that sense, these two economically
efficient situations have a different distribution of income.
3.17 Discuss: "The hour-for-hour trade requires 6 1/2 total hours of work from Steve and Lauren, while the original trade required only 6 hours of work, so the hour-for-hour trade is economically inefficient."
Although the hour-for-hour trade requires more total hours of work, it is economically efficient because there is no way to change it so that both Steve and Lauren gain, or so that one gains while the other does not lose. Lauren and Steve both gain leisure time with the hour-for hour trade (as compared to the no trade situation), though Steve gains more from the hour-for-hour trade, and Lauren gains more from trading one hour for two hours.
3.18 How do taxes cause economic inefficiency?
Taxes cause economic inefficiency because they create incentives not to trade (to avoid paying taxes on the trade) even though those trades would change the economy from economically inefficient to economically efficient situations.
Here is another explanation: Steve and Lauren may benefit from a particular
trade, but the total benefits of that trade (which they would share in
some way) may be smaller than the tax they have to pay if they trade!
In that case, they find it better not to trade and not pay the tax.
(This is true even though that trade would have helped them both in the
absence of a tax.)
3.19 – Explain why the Economy is a positive-sum game.
A positive-sum game is a win-win situation in which everyone gains,
that is opposite to a zero-sum gain in which one person´s gain is
another person´s loss.
The economy is a positive-sum game because one person´s
gain is not another person´s loss. Both participants gain in voluntary
trades.
3.21 – Consider the shoe-store example from Table 1 of Chapter 1. Change the numbers so that Lisa needs 8 hours (instead of 4) to take inventory. How does this change affect who has a comparative advantage at which task and the gains from trade?
This change does not change which person has a comparative advantage at which task: Lisa still has a comparative advantage at setting up displays, because her opportunity cost of doing that is lower than Mitch's. Mitch still has a comparative advantage at taking inventories, because his opportunity cost of doing that is lower than Lisa's.
However, this change does raise the amount of time Lisa would spend working without the trade, so it also raises her gain from trading with Mitch.