**Terms of Trade Cheat Sheet**

John can either produce 200 donuts or 100 cupcakes. If he makes 200 donuts he gives up 100 cupcakes (100/200 = .5 or 1/2). Said in a different way, for every donut John makes he gives up 1/2 of a cupcake or for every cupcake he makes he gives up 2 donuts. (200/100 = 2)

Erica, on the other hand, can either make 150 donuts or 50 cupcakes. If she makes 150 donuts she gives up 50 cupcakes (50/150 = .333... or 1/3). Said in a different way, for every donut Erica makes she gives up a 1/3 of a cupcake or for every cupcake she makes she gives up 3 donuts. (150/50 = 3)

As Erica's opportunity cost of producing 1 donut is 1/3 of a cupcake, which is less than John's opportunity cost which is 1/2 of a cupcake for every donut he makes.

Remember that **comparative advantage** is about who gives up less than the other person, as **lower opportunity cost is the key.**

If John and Erica specialise then Erica would make the donuts and John would make cupcakes.

Before specialisation John could make a cupcake or two donuts, said another way, if John makes two donuts he gives up a cupcake. After trade and specialisation John can trade a cupcake for 4 donuts. He would be better off.

Before specialisation Erica could make a donut and give up 1/3 of a cupcake. Said another way, Erica could make a cupcake and give up 3 donuts. After trade and specialisation Erica would have to give up 4 donuts for 1 cupcake. **This would not be beneficial for Erica.**

Understand, that Erica's production of donuts will not increase but her ability to produce more cupcakes with the same resources will increase.

(Equal Amounts of Resources = Output/Over Problem)

Make a chart and cross multiply (over) |

Look at the chart - Understand that you only make two goods, so your opportunity cost is what you give up of the other good. In this instance the opportunity cost of a bicycle is how many hats you give up for one bicycle.

OK, so this is the college board trying to be very tricky.

If Art should produce Bicycles as it only gives up 2 hats for each bicycle it makes then Art should produce Bicycles and import hats.

Since, Ray will produce hats as its opportunity cost is lowest for bicycles, it will import bicycles.

Understand what is happening - Artland is making bicycles and Rayland is making hats, if the terms of trade are 5 hats for 1 bicycle and Artland is making bicycles then they would give up one bike and get 5 hats. Pretty Good!!! - - - But, Rayland is making hats and the terms are trade are 5 hats for 1 bicycle - right now Rayland can give up 4 hats to get a bicycle. If they accept these terms of trade they will be giving up 1 extra hat for a bicycle.

If the production capabilities triple in one country for both goods then the ratios remain the same

300/1200 = .25 or

900/3600 = .25

Take a moment to see what is going on. The coloured circles show who has the lowest opportunity cost in that column. |

Understand that the opportunity cost of 1 unit of cloth is the mount of food that must be given up.

2/10 = .2 or 20% or 1/5

In essence, Newline must give up producing 1/5 of a unit of food to produce 1 unit of cloth

1/10 = .1 or 10% or 1/10

Beeline, to produce 1 unit of food must give up 10 units of cloth.

Do the cross multiplying (over) and then evaluate in the cloth column who has the lowest opportunity cost. In essence, who will give up less resources in producing this good.

Cross multiply, and then look at the food column and see who has the lowest opportunity cost. Who can produce a unit of food and give up the least resources.

You must know what an absolute advantage is...

Since, using the same amount of resources tells us that this is an output problem

(inputs are fixed and the output is variable)

Each country uses the same resources, who produces more has absolute advantage

Tractors - Xanadu using the same resources has an output (production) of 40 > 10

Understand, that if Atlantis has the comparative advantage in producing cars so it will produce cars domestically.

Xanadu has the comparative advantage in producing tractors, so it will produce tractors and import cars.

I'm Atlantis and I have 3 cars but I want a tractor. Jed comes up to me and says he has a tractor to sell but its gonna cost me 3 cars. Now Jung Sub shows up and he has a tractor to sell me and he only wants 1 car. By trading with Jung Sub instead of Jed I've gained/not lost 2 cars.

I'm Xanadu, I have tractors and I want to purchase a car. Chris offers to sell me a car but she wants 2 tractors. (Don't be a bitch Chris!) Instead, Jamie comes along and offers me a car for only 1 tractor. I win and save myself the cost of 1 tractor by trading with Jamie.

Look at the graph, using equal resources Luna can produce 40 machines to Ashna's 10. (40>10)

(Understand that turning this around might be closer to what they want but I'd be willing to bet they would accept any explanation as long as it is correct.)

Surplus = Exports > Imports

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