HOW PEOPLE MAKE DECISIONS

Principle #2: The Cost of Something Is

What You Give Up to Get It

▪ The opportunity cost of any item is

whatever must be given up to obtain it.

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Exercises
 Choose a definition for each key term

1.Whatever is given up to obtain some

item
a.Absolute 2. The ability to produce a good at a lower
advantage opportunity cost than another producer
b.Comparative 3. Goods produced domestically and sold
advantage abroad
c.Gains from trade 4. Goods produced abroad and sold
d.Opportunity cost domestically
e.Imports 5. The ability to produce a good using
f.Exports fewer inputs than another producer
6. The increase in total production due to
specialization allowed by trade
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 Short-Answer Questions
1. Why do people choose to become
interdependent as opposed to self-sufficient?
2. Why is comparative advantage important in
determining trade instead of absolute
advantage?
3. Why is a restriction of trade likely to reduce
material welfare?

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 True/False Questions
1. Comparative advantage, not absolute advantage,
determines the decision to specialize in production.
2. Absolute advantage is a comparison among producers
based on productivity.
3. Self-sufficiency is the best way to increase one's
material welfare.
4. Comparative advantage is a comparison among
producers based on opportunity cost.

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 Multiple-Choice Questions
1. If a nation has an absolute advantage in the production of a good,
a. it can produce that good at a lower opp. cost than its trading partner.
b. it can produce that good using fewer resources than its trading partner.
c. it can benefit by restricting imports of that good.
d. it will specialize in the production of that good and export it.
e. none of the above is true.
2. If a nation has a comparative advantage in the production of a good,
a. it can produce that good at a lower opp. cost than its trading partner.
b. it can produce that good using fewer resources than its trading parmer.
c. it can benefit by restricting imports of that good.
d. it must be the only country with the ability to produce that good.
e. none of the above is true.
3. Suppose a country's workers can produce 4 watches per hour or 12 rings per
hour. If there is no trade,
a. the opportunity cost of 1 watch is 3 rings
b. the opportunity cost of 1 watch is 1/3 of a ring.
e. the opportunity cost of 1 watch is 4 rings.
d. the opportunity cost of 1 watch is351/4 of a
e. the opportunity cost of 1 watch is 12 rings.
 Advanced critical thinking
1. In the real world, does every person in the
country gain when restrictions on imports are
reduced? Explained.

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