Unlocking Global Trade: Comparative Advantage and Terms of Trade

Economics Grades High School 9:56 Video
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Lesson Description

Explore the principles of comparative advantage and terms of trade to understand how countries benefit from specialization and trade in a global economy.

Video Resource

Terms of Trade and the Gains from Trade | AP Macroeconomics | Khan Academy

Khan Academy

Duration: 9:56
Watch on YouTube

Key Concepts

  • Production Possibility Curve (PPC)
  • Opportunity Cost
  • Comparative Advantage
  • Terms of Trade
  • Gains from Trade

Learning Objectives

  • Students will be able to define and calculate opportunity cost.
  • Students will be able to determine comparative advantage based on opportunity costs.
  • Students will be able to explain how specialization and trade lead to gains from trade.
  • Students will be able to identify acceptable terms of trade that benefit both trading partners.

Educator Instructions

  • Introduction (5 mins)
    Begin by reviewing the concept of scarcity and the need for choices. Briefly introduce the idea of international trade and its potential benefits. Ask students if they know where the items they use daily are produced and why that might be the case.
  • Video Viewing (15 mins)
    Play the Khan Academy video: "Terms of Trade and the Gains from Trade | AP Macroeconomics | Khan Academy." Instruct students to take notes on the key concepts presented in the video, focusing on opportunity cost, comparative advantage, and terms of trade.
  • Guided Practice (15 mins)
    Work through the example presented in the video, pausing to explain each step in detail. Emphasize how to calculate opportunity costs from the production possibility curves or output tables. Guide students through identifying which country has a comparative advantage in each good. Discuss how to determine a mutually beneficial trading price (terms of trade).
  • Independent Practice (15 mins)
    Present students with a new scenario involving two countries and two goods. Provide them with either production possibility data or an output table. Have them independently calculate opportunity costs, determine comparative advantage, and suggest a possible terms of trade. This could be done individually or in small groups.
  • Wrap-up and Discussion (10 mins)
    Review the key concepts and address any remaining questions. Discuss the benefits of specialization and trade, even if one country is more productive in all goods (absolute advantage vs. comparative advantage).

Interactive Exercises

  • Comparative Advantage Simulation
    Divide the class into two groups, representing two countries. Assign each group different production capabilities for two goods (e.g., wheat and textiles). Have them simulate production and trade, illustrating the gains from specialization and trade based on comparative advantage. Consider adding costs of trade (tariffs).
  • Terms of Trade Negotiation
    Building on the previous exercise, have the groups negotiate the terms of trade. This could involve a time limit and negotiation tactics, with the goal of maximizing the benefit for their respective country.

Discussion Questions

  • How does specializing based on comparative advantage differ from specializing based on absolute advantage?
  • What factors might prevent countries from fully specializing in the production of goods for which they have a comparative advantage?
  • How do terms of trade affect the distribution of gains from trade between countries?
  • Can you think of a real-world example of two countries trading based on comparative advantage?

Skills Developed

  • Critical Thinking
  • Problem Solving
  • Analytical Skills
  • Economic Reasoning

Multiple Choice Questions

Question 1:

Opportunity cost is best defined as:

Correct Answer: The next best alternative forgone when making a decision.

Question 2:

A country has a comparative advantage in producing a good if it:

Correct Answer: Has the lowest opportunity cost of producing the good.

Question 3:

Specialization and trade based on comparative advantage lead to:

Correct Answer: Increased consumption possibilities for both countries.

Question 4:

The 'terms of trade' refers to:

Correct Answer: The ratio at which two countries will exchange goods.

Question 5:

A production possibilities curve (PPC) illustrates:

Correct Answer: The different combinations of goods an economy can produce given its resources and technology.

Question 6:

If Country A can produce 10 cars or 20 bushels of wheat, and Country B can produce 12 cars or 24 bushels of wheat, which country has the comparative advantage in car production?

Correct Answer: Neither, they both have the same comparative advantage

Question 7:

Using the same information in the question above, what is the opportunity cost of one car for Country A?

Correct Answer: 2 bushels of wheat

Question 8:

For trade to be mutually beneficial, the terms of trade must fall:

Correct Answer: Between the two countries' opportunity costs

Question 9:

Gains from trade occur because trade allows:

Correct Answer: Countries to consume outside their PPF

Question 10:

Which of the following is NOT a reason for countries to trade?

Correct Answer: Differences in consumer preferences

Fill in the Blank Questions

Question 1:

The _______ _______ is the value of the next best alternative that is forgone when a decision is made.

Correct Answer: opportunity cost

Question 2:

A country has a _______ _______ in the production of a good if it can produce that good at a lower opportunity cost than another country.

Correct Answer: comparative advantage

Question 3:

The _______ _______ _______ define the rate at which one good can be exchanged for another.

Correct Answer: terms of trade

Question 4:

A _______ _______ _______ shows the maximum combinations of goods and services that an economy can produce given its resources and technology.

Correct Answer: production possibilities curve

Question 5:

When countries specialize in producing goods for which they have a comparative advantage and then trade, both countries experience _______ _______ _______.

Correct Answer: gains from trade

Question 6:

If a country can produce more of a good than another country, it has _______ _______ in producing that good.

Correct Answer: absolute advantage

Question 7:

Countries should specialize in producing goods for which they have a _______ _______.

Correct Answer: comparative advantage

Question 8:

When trade occurs, consumption possibilities can be _______ than production possibilities.

Correct Answer: greater

Question 9:

The theory of comparative advantage was popularized by economist _______ _______.

Correct Answer: David Ricardo

Question 10:

A trading price between two countries will be acceptable if it's between both countries' _______ _______.

Correct Answer: opportunity costs

Educational Standards

SOC.9-12.E.2.5:Describe the impact of comparative and absolute advantage upon the three basic economic questions. SOC.9-12.E.1.1:Define and apply basic economic concepts of money supply, scarcity, surplus, choice, opportunity cost, cost/benefit analysis, risk/reward relationship, incentive, disincentive, and trade-off to a variety of economic situations. SOC.9-12.E.2.2:Describe the role of the factors of production, land, labor, capital, entrepreneurship, and technology as well as the place of imports and exports in economic systems.

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