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Chapter 3Chapter 3Chapter 3Chapter 3
2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited
Interdependence Interdependence and the Gains and the Gains
from Tradefrom Trade
Interdependence Interdependence and the Gains and the Gains
from Tradefrom Trade
Chapter 3: Page 2
In this chapter you will…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.
• 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 3
Interdependence and the Gains Interdependence and the Gains from Tradefrom 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.
• 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 4
Interdependence and the Gains Interdependence and the Gains from Tradefrom 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.
• 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 5
Interdependence and the Gains Interdependence and the Gains from Tradefrom Trade
• Economics studies how society produces and distributes goods and services so that wants and needs are satisfied.
• Trade can make everyone better off.
• 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 6
Interdependence and the Gains Interdependence and the Gains from Tradefrom 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 InterdependenceEconomic Interdependence.
• How do we satisfy our wants and needs?
• We can be economically Self-Sufficient.
• We can specialize and trade with others leading to Economic InterdependenceEconomic Interdependence.
Chapter 3: Page 7
Interdependence and the Gains Interdependence and the Gains from Tradefrom 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?
• 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 8
Interdependence and the Gains Interdependence and the Gains from Tradefrom Trade
• Why is interdependence the norm? 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.
• Why is interdependence the norm? 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 9
A PARABLE FOR MODERN ECONOMYA PARABLE FOR MODERN ECONOMY
• Imagine that there are…… two goods in the world:
1. Potatoes2. Meat
… and two people in the world:1. Potato farmer2. Cattle rancher
• What should each produce?• Why should they trade?
• Imagine that there are…… two goods in the world:
1. Potatoes2. Meat
… and two people in the world:1. Potato farmer2. Cattle rancher
• What should each produce?• Why should they trade?
Chapter 3: Page 10
Table 3-1: the Production Opportunities of Table 3-1: the Production Opportunities of the Farmer and the Rancherthe Farmer and the Rancher
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 ...
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 ...
166428Rancher
8811Farmer
PotatoesMeatPotatoesMeat
Amount produced in 8 Hours (in Kg)
Amount produced in 1 Hour (in Kg)
Chapter 3: Page 11
Figure 3-1(A): The Farmer’s Production Figure 3-1(A): The Farmer’s Production Possibilities Frontier Possibilities Frontier
Meat (kilograms)
Potatoes (kilograms)
0
8
8
4
4
A
Derived from Table 3-1 by working 8 hours a day
Chapter 3: Page 12
Meat (kilograms)
Potatoes (kilograms)
0
64
16
32
8
B
Figure 3-1(B): The Rancher’s Production Figure 3-1(B): The Rancher’s Production Possibilities Frontier Possibilities Frontier
Derived from Table 3-1 by working 8 hours a day
Chapter 3: Page 13
Specialization and TradeSpecialization 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 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 14
Meat (kilograms)
Potatoes (kilograms)
0
8
8
4
4
A
6
5
A* Consumption with trade
Consumption without trade
Figure 3-2 (A): How Trade Increases the Figure 3-2 (A): How Trade Increases the Framer’s Consumption Framer’s Consumption
Chapter 3: Page 15
Meat (kilograms)
Potatoes (kilograms)
0
64
16
32
8
B
34
9
B*Consumption with trade
Consumption without trade
Figure 3-2 (B): How Trade Increases the Figure 3-2 (B): How Trade Increases the Rancher’s Consumption Rancher’s Consumption
Chapter 3: Page 16
THE PRINCIPLE OF THE PRINCIPLE OF COMPARATIVE ADVANTAGECOMPARATIVE ADVANTAGE
• Differences in the costs of production determine the following:– Who should produce what?– How much should be traded for
each product?
• 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 17
• 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.
• 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.
THE PRINCIPLE OF THE PRINCIPLE OF COMPARATIVE ADVANTAGECOMPARATIVE ADVANTAGE
Chapter 3: Page 18
Absolute AdvantageAbsolute 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
• 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 19
Table 3-3: The Opportunity Cost of Table 3-3: The Opportunity Cost of Meat and PotatoesMeat and Potatoes
• 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?
• 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?
1/4Rancher
1Farmer
Meat (in terms of potatoes given up)
Opportunity Cost of 1 Kg of
Potatoes (in terms of meat given up)
4
1
Chapter 3: Page 20
• 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.
• 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.
Opportunity Cost and Opportunity Cost and Comparative AdvantageComparative Advantage
Chapter 3: Page 21
• 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.
• 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.
Opportunity Cost and Opportunity Cost and Comparative AdvantageComparative Advantage
Chapter 3: Page 22
• 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...
• 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...
Comparative Advantage and TradeComparative Advantage and Trade
Chapter 3: Page 23
Comparative Advantage and TradeComparative Advantage and Trade
• The Rancher has the Comparative Advantage in producing Meat (lower opportunity cost).
• The Farmer has the Comparative Advantage in producing Potatoes (lower opportunity cost)
• 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 24
Comparative Advantage and TradeComparative 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.
• 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 25
Comparative Advantage and TradeComparative 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.”
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 26
APPLICATIONS OF APPLICATIONS OF COMPARATIVE ADVANTAGECOMPARATIVE ADVANTAGE
• The principle of comparative advantage has many applications. Here are two examples:– Joe Sakic and his lawn.– Canada and other countries.
• The principle of comparative advantage has many applications. Here are two examples:– Joe Sakic and his lawn.– Canada and other countries.
Chapter 3: Page 27
Should Joe Sakic Mow His Own Should Joe Sakic Mow His Own Lawn?Lawn?
• Absolute Advantage. . .• Opportunity Costs. . .• Gains from trade. . .
• Absolute Advantage. . .• Opportunity Costs. . .• Gains from trade. . .
Chapter 3: Page 28
Should Canada Trade with other Should Canada Trade with other Countries?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
• 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 29
SummarySummary
• 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.
• 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 30
SummarySummary
• 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.
• 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 31
SummarySummary
• 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.
• 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 32
The EndThe End
