Transcript Document

Chapter 3
Interdependence
and the Gains
from Trade
2002 by Nelson, a division of Thomson Canada Limited
In this chapter you will…
•
•
•
•
Consider how everyone can benefit
when people trade with another
country.
Learn the meaning of absolute
advantage and comparative advantage.
See how comparative advantage
explains the gains from trade.
Apply the theory of comparative
advantage to everyday life and national
policy.
Chapter 3: Page 2
Interdependence and the Gains
from Trade
• Consider your typical day:
– You pour yourself orange juice made
from Florida oranges and coffee from
beans grown in Brazil.
– You put on some clothes made of
cotton grown in Georgia and sewn in
factories in Thailand.
– You watch the morning news broadcast
from New York on your TV made in
Japan.
Chapter 3: Page 3
Interdependence and the Gains
from Trade
• Consider your typical day (more):
– You drive to class in a car made of parts
manufactured in a half-dozen different
countries.
– Then you open your economics
textbook written by authors living in
Massachusetts, Alberta, and Quebec,
published by a company located in
Ontario, and printed from paper made
from trees grown in New Brunswick.
Chapter 3: Page 4
Interdependence and the Gains
from Trade
• Economics studies how society
produces and distributes goods and
services so that wants and needs are
satisfied.
• Trade can make everyone better off.
Chapter 3: Page 5
Interdependence and the Gains
from Trade
• How do we satisfy our wants
and needs?
• We can be economically Self-
Sufficient.
• We can specialize and trade
with others leading to
Economic Interdependence.
Chapter 3: Page 6
Interdependence and the Gains
from Trade
• A general observation . . .
–
Individuals and nations rely on
specialized production and exchange
as a way to address problems caused
by scarcity.
• This gives rise to two questions. . .
–
–
Why is interdependence the norm?
What determines production & trade?
Chapter 3: Page 7
Interdependence and the Gains
from Trade
•
Why is interdependence the norm?

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Interdependence occurs because
people are better off when they
specialize and trade with others.
What determines the pattern of
production & trade?

Patterns of production and trade
are based upon differences in
opportunity costs.
Chapter 3: Page 8
A PARABLE FOR MODERN ECONOMY
• Imagine that there are…
… two goods in the world:
1. Potatoes
2. Meat
… and two people in the world:
1. Potato farmer
2. Cattle rancher
• What should each produce?
• Why should they trade?
Chapter 3: Page 9
Table 3-1: the Production Opportunities of
the Farmer and the Rancher
Amount produced in
1 Hour (in Kg)


Amount produced in
8 Hours (in Kg)
Meat
Potatoes
Meat
Potatoes
Farmer
1
1
8
8
Rancher
8
2
64
16
Note that based on the Productivity Table above
the Rancher is more productive in producing
both of the products.
Yet, we will see that both the Rancher and the
Farmer can gain from trade ...
Chapter 3: Page 10
Figure 3-1(A): The Farmer’s Production
Possibilities Frontier
Meat
(kilograms)
Derived from Table 3-1 by working 8 hours a day
8
A
4
0
4
8
Potatoes
(kilograms)
Chapter 3: Page 11
Figure 3-1(B): The Rancher’s Production
Possibilities Frontier
Meat
(kilograms)
Derived from Table 3-1 by working 8 hours a day
64
B
32
0
8
16
Potatoes
(kilograms)
Chapter 3: Page 12
Specialization and Trade
•
The Farmer and the Rancher Specialize
and Trade
– Each would be better off if they
specialized in producing the product
they are more suited to produce, and
then trade with each other.
The farmer should produce potatoes.
The rancher should produce meat.
They should trade
Chapter 3: Page 13
Figure 3-2 (A): How Trade Increases the
Framer’s Consumption
Meat
(kilograms)
8
A*
6
Consumption
with trade
A
Consumption
without trade
4
0
4
5
8
Potatoes
(kilograms)
Chapter 3: Page 14
Figure 3-2 (B): How Trade Increases the
Rancher’s Consumption
Meat
(kilograms)
64
B*
34
Consumption
without trade
32
B
0
Consumption
with trade
8
9
16
Potatoes
(kilograms)
Chapter 3: Page 15
THE PRINCIPLE OF
COMPARATIVE ADVANTAGE
• Differences in the costs of
production determine the following:
– Who should produce what?
– How much should be traded for
each product?
Who can produce potatoes at a lower
cost? The farmer or the rancher!
Chapter 3: Page 16
THE PRINCIPLE OF
COMPARATIVE ADVANTAGE
•
Measuring differences in costs of
production:
– Number of hours required to produce
a standardized unit of output.
 One pound of potatoes
–
Opportunity Cost: Whatever must be
given up to obtain some item.
Chapter 3: Page 17
Absolute Advantage
• Describes the productivity of one
person, firm, or nation to that of
another.
- The producer that requires a
smaller quantity of inputs to
produce a good is said to have an
absolute advantage in producing
that good
Chapter 3: Page 18
Table 3-3: The Opportunity Cost of
Meat and Potatoes
Opportunity Cost of 1 Kg of
Farmer
Rancher
•
•
•
Meat (in terms of
Potatoes (in terms of
potatoes given up)
meat given up)
1
1
1/4
4
Who has the Absolute Advantage in each
product?
Rancher, in both products!
Yet, we have seen that both the Rancher and the
Farmer can gain from trade?
Chapter 3: Page 19
Opportunity Cost and
Comparative Advantage
• The comparison among producers
of a good according to their
opportunity cost.
-
The producer who has the smaller
opportunity cost of producing a good
is said to have a comparative
advantage in producing that good.
Chapter 3: Page 20
Opportunity Cost and
Comparative Advantage
• Comparative advantage, which
refers to differences in opportunity
costs, is the basis for specialized
production and trade.
• Whenever potential trading parties
have differences in opportunity
costs, they can each benefit from
trade.
Chapter 3: Page 21
Comparative Advantage and Trade
•
Based on the earlier Productivity Table
(Table 3-3 - Slide 19)…
–
The Rancher’s opportunity cost of 1 Kg of
potatoes is 4 Kg of meat, whereas the
Farmer’s opportunity cost of a Kg of
potatoes is 1 Kg of meat.
–
The Rancher’s opportunity cost of 1 Kg of
meat is only 1/4 Kg of potatoes, while the
Farmer’s opportunity cost of 1 Kg of meat is
only 1 Kg of potatoes...
Chapter 3: Page 22
Comparative Advantage and Trade
•
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The Rancher has the Comparative
Advantage in producing Meat (lower
opportunity cost).
The Farmer has the Comparative
Advantage in producing Potatoes (lower
opportunity cost)
Chapter 3: Page 23
Comparative Advantage and Trade
• Comparative advantage and
differences in opportunity costs are
the basis for specialized production
and trade.
• Whenever potential trading parties
have differences in opportunity
costs, they can each benefit from
trade.
Chapter 3: Page 24
Comparative Advantage and Trade
Moral of the Story:
“Trade can benefit everyone in a society
because it allows people to specialize in
activities in which they have a
comparative advantage.”
Chapter 3: Page 25
APPLICATIONS OF
COMPARATIVE ADVANTAGE
• The principle of comparative advantage
has many applications. Here are two
examples:
– Joe Sakic and his lawn.
– Canada and other countries.
Chapter 3: Page 26
Should Joe Sakic Mow His Own
Lawn?
• Absolute Advantage. . .
• Opportunity Costs. . .
• Gains from trade. . .
Chapter 3: Page 27
Should Canada Trade with other
Countries?
• Each country has many citizens with
different interests. International trade can
make some individuals worse off, even as
it makes the country as a whole better off.
– Imports: goods produced abroad and
sold domestically
– Exports: goods produced domestically
and sold abroad
Chapter 3: Page 28
Summary
• Each person consumes goods and
services produced by many other people
both in our country and around the world.
• Interdependence and trade are desirable
because they allow everyone to enjoy a
greater quantity and variety of goods and
services.
Chapter 3: Page 29
Summary
• There are two ways to compare the ability
of two people producing a good.
– The person who can produce a good
with a smaller quantity of inputs has an
absolute advantage.
– The person with a smaller opportunity
cost has a comparative advantage.
Chapter 3: Page 30
Summary
• The gains from trade are based on
comparative advantage, not absolute
advantage.
• Trade makes everyone better off because
it allows people to specialize in those
activities in which they have a
comparative advantage.
• The principle of comparative advantage
applies to countries as well as people.
Chapter 3: Page 31
The End
Chapter 3: Page 32