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Main content
Current time:0:00Total duration:9:56
AP.MACRO:
MKT‑1 (EU)
,
MKT‑1.B (LO)
,
MKT‑1.B.1 (EK)
,
MKT‑1.B.2 (EK)
AP.MICRO:
MKT‑2 (EU)
,
MKT‑2.B (LO)
,
MKT‑2.B.1 (EK)
,
MKT‑2.B.2 (EK)

Video transcript

let's imagine a very simple world as we tend to do in economics that has two countries that are each capable of producing either pants or shirts or some combination and so what we have here are the production possibility curve for each of those countries and this is in per worker per day so for example in country a part worker per day they could if they put all of their energy into pants they could produce 20 if they put all their energy into shirts they could produce 10 or there could be some combination that would sit on this line now to help us digest the production possibility curve for these two countries let me construct an output table so this will be this column will be the output for country a this column will be the output for country B and we're gonna think about the maximum number of pants maximum pants the maximum output of pants per worker per day the input is the worker per day and then let's think about the maximum number of shirts so pause this video and see if you can fill this out what are the max pants and shirts in country a and Country B well in country I already talked about it the maximum pants is 2020 pants and then the maximum shirts if they didn't make any pants are 10 and in country B the maximum pants are 30 and the maximum shirts it looks like that is about 45 now from either these production possibility curve or from this output table because we have a constant opportunity cost these production possibility curve are straight lines with a fixed slope we can calculate the opportunity cost so let's do that next so this is country a and then this is country B and let me calculate the opportunity cost of pants and let's calculate the opportunity cost of shirts so pause this video and see if you can figure that out what are the opportunities of pants and shirts in countries a and B and fill out this table well one way to think about it in country a I could put all of my energy into pants and produce 20 pants or I could put all of my energy into shirts and produce 10 shirts 10 shirts s for sure it's P for pants and so if I want the cost of pants I could just divide both sides by 20 and I would get pants the amount of energy per pant is equal to well 10 divided by 20 is 1/2 a shirt so the energy for pant is 1/2 4 it is the same as the energy for half a shirt and so we could say the opportunity cost of producing a pant is half a shirt if we want the opportunity cost for shirts we could take the reciprocal of this number we could say it's going to be 2 over 1 pants or we could start with this equation right over here and instead of solving for P we could solve for s how much energy in terms of pants does it take for us to produce one shirt so if you divide both sides of this equation by 10 you would get you would get 2 P is equal to s or another way of thinking about it the energy to create one shirt is equal to the energy to create 2 pants so the opportunity cost of producing a shirt is 2 pants so that same energy of the shirt you could produce 2 pants now let's also fill it out for country B and if you haven't done so already try to use the same method to fill this the opportunity cost for pants and shirts for country B well in country B I could put all of my energy into pants and produce 30 pants or all of my energy and two shirts and produce 45 shirts so the opportunity cost per pant if I divide both sides by 30 it would be 45 over 30 which would be equal to they're both divisible by 15 three halves of a shirt the energy for one pair of pants is the same as the energy for one and a half shirts I guess I could say so let me write it that way so the opportunity cost of pants is for each pair I'm giving up one and a half shirts and then in the opportunity cost for shirts well I could just solve for s here if I divide both sides by 45 I get the same energy for one shirt would be thirty forty fifth of a pair of pants which is the same thing as 2/3 of a pair of pants and so I could write that as 2/3 of a pair of pants or if I let me just write it that way two-thirds of a pair of pants so given the opportunity costs what should each of these countries focus on pause this video and try to figure that out well let's first compare their opportunity costs in pants so let's first compare their opportunity cost in pants it is clear that country a has a lower opportunity cost for producing a pair of pants it's only giving up half a shirt while country B is giving up one and a half shirts so country a has the comparative advantage right over here so comparative advantage right over here in pants and so it should focus all of its energy according to the theory of comparative advantage it should focus all of its energy on pants and likewise if we look at so here we compared this to this and likewise if we try to look at shirts right over here if we look at their opportunity costs country B is only giving up two-thirds of a pair of pants while country a would be giving up two pairs of pants so country B has the lower opportunity cost or the comparative advantage in shirts so country B should put all of their focus here on shirts now I know what you might be thinking people can't just walk around wearing only shirts that might people might get cold below their waist or people don't want to wear only wear pants they might get cold above their waist and so how can people in these countries get the other type of garment well the obvious answer is if they focus in this way they can trade and what would be an acceptable trading price let's say for pants let's focus on pants for a second so if we're thinking about the market for pants so if your country a what would you be willing to sell pants for in terms of shirts well a good price so to speak would be something higher than your opportunity cost so a willing to sell sell pants at price I'll put that in quotes because we're really thinking of price in terms of another good at price greater than their opportunity cost greater than 1/2 of a shirt and you could think of this willing to trade or sell I'll put that in quotes they're really trading in our everyday language right over here and likewise what about country be well be willing to buy pants they need pants there otherwise they would just be walking around with only shirts on willing to buy pants at a price at a price less than their opportunity costs for pants and so that would be less than 1.5 of a shirt so what would be a price that is greater than half a shirt and less than 1/2 and less than 1 and 1/2 of a shirt and really any price in between these two values would work well a nice round number is well they could trade at one pair of pants for one shirt so a clearing price a price that would work could be 1p one pants for one shirt and now let's appreciate the gains from trade that they would both have here so let's imagine this world where country a is producing 20 pants per worker per day but let's say they decide that they want instead of those 20 pants they would want to trade 15 of them away for shirts and so they would get at this price they would get 15 shirts so they're gonna give up 15 pants they're giving up 15 pants so they'll only have 5 pants right over here but they're going to get 15 shirts so they're gonna get 15 shirts and they're going to end up right over here this is where a country a is going to end up and what's cool about this is we've gone beyond the production possibilities curve so you see Claire clearly the gain from trade country--a could not have gotten to this point on its own this is above the production possibilities curve likewise country B was over here with 45 shirts it gave up 15 of those shirts it now has 30 shirts but it now has 15 pants at least some of the people in the country are going to be able to wear pants now so it now has 15 pants once again it too is in a point beyond its production possibilities curve it would not have been able to get here without the trade so they are both better off so the key thing the key takeaway from this video is we now appreciate why comparative advantage is valuable once again making all the assumptions for these simplified economic models because we can calculate our opportunity cost from that comparative advantage and then we could think about what's a good price that they'll be willing to trade at and see that when they trade they both are able to get beyond their production possibilities curve
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