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Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from...

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3 Basic Macroeconomics Interdependence and the Gains from Trade Consider your typical day: You wake up to an alarm clock made in China. 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 Malawi and sewn in factories in Bangladesh. You watch the morning news broadcast from New York on your TV made in Japan. You drive to class in a car made of parts manufactured in a half- dozen different countries.
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Page 1: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

3Basic

Macro

econom

ics

Inte

rdependence a

nd th

e G

ain

s fro

m T

rade

•C

onsid

er y

our ty

pic

al d

ay:

•Y

ou

wa

ke

up

to a

n a

larm

clo

ck m

ad

e in

Ch

ina

.

•Y

ou

po

ur y

ou

rse

lf ora

ng

e ju

ice

ma

de

from

Flo

rida

ora

ng

es a

nd

co

ffee

from

be

an

s g

row

n in

Bra

zil.

•Y

ou

pu

t on

so

me

clo

the

s m

ad

e o

f co

tton

gro

wn

in M

ala

wi a

nd

se

wn

in

facto

ries in

Ba

ng

lad

esh

.

•Y

ou

wa

tch

the

mo

rnin

g n

ew

s b

roa

dca

st fro

m N

ew

Yo

rk o

n y

ou

r TV

m

ad

e in

Ja

pa

n.

•Y

ou

driv

e to

cla

ss in

a c

ar m

ad

e o

f pa

rts m

an

ufa

ctu

red

in a

ha

lf-d

oze

n d

iffere

nt c

ou

ntrie

s.

Page 2: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Inte

rdependence

and th

e G

ain

s from

Tra

de

•R

em

em

ber, e

conom

ics is

the s

tudy o

f how

socie

ties

pro

duce a

nd d

istrib

ute

goods in

an a

ttem

pt to

satis

fy th

e

wants

and n

eeds o

f its m

em

bers

.

Inte

rdependence

and th

e G

ain

s from

Tra

de

•H

ow

do w

e s

atis

fy o

ur w

ants

and n

eeds in

a g

lobal

econom

y?

•W

e c

an

be

eco

no

mic

ally

se

lf-su

fficie

nt.

•W

e c

an

sp

ecia

lize

an

d tra

de

with

oth

ers

, lea

din

g to

e

co

no

mic

inte

rde

pe

nd

en

ce

.

Page 3: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Inte

rdependence

and th

e G

ain

s from

Tra

de

•In

div

iduals

and n

atio

ns re

ly o

n s

pecia

lized p

roductio

n a

nd

exchange a

s a

way to

addre

ss p

roble

ms c

aused b

y

scarc

ity.

•B

ut th

is g

ives ris

e to

two q

uestio

ns:

•W

hy is

inte

rde

pe

nd

ence

the

no

rm?

•W

ha

t de

term

ine

s p

rod

uctio

n a

nd

trad

e?

Inte

rdependence

and th

e G

ain

s from

Tra

de

•W

hy is

inte

rdependence th

e n

orm

?

•In

terd

ep

en

de

nce

occu

rs b

eca

use

pe

op

le a

re b

ette

r off w

he

n th

ey

sp

ecia

lize

an

d tra

de

with

oth

ers

.

•W

hat d

ete

rmin

es th

e p

atte

rn o

f pro

ductio

n a

nd tra

de?

•P

atte

rns o

f pro

du

ctio

n a

nd

trad

e a

re b

ase

d u

po

n d

iffere

nce

s in

o

pp

ortu

nity

co

sts

.

Page 4: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

A P

AR

AB

LE

FO

R T

HE

MO

DE

RN

EC

ON

OM

Y•

Imagin

e . . .

•o

nly

two

go

od

s: p

ota

toe

s a

nd

me

at

•o

nly

two

peo

ple: a p

otato

farmer an

d a cattle

ranch

er

•W

hat sh

ou

ld each

pro

du

ce?

•W

hy

sho

uld

they

trade?

Table

1 T

he P

roductio

n O

pportu

nitie

s of th

e F

arm

er a

nd R

anch

er

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

Page 5: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Pro

ductio

n P

ossib

ilities

•S

elf-S

uffic

iency

•B

y ig

norin

g e

ach o

ther:

•E

ach

co

nsu

me

s w

ha

t the

y e

ach

pro

du

ce

.

•T

he

pro

du

ctio

n p

ossib

ilities fro

ntie

r is a

lso

the

co

nsu

mp

tion

po

ssib

ilities fro

ntie

r.

•W

itho

ut tra

de

, eco

no

mic

ga

ins a

re d

imin

ish

ed

.

Fig

ure

1 T

he P

roductio

n P

ossib

ilities C

urveP

ota

toe

s (o

un

ce

s)

4

16

8

32

A

0

Me

at (o

un

ce

s)

(a) T

he

Fa

rme

r’s

Pro

du

ctio

n P

os

sib

ilities

Fro

ntie

r

If the

re is

no

trad

e,

the

farm

er c

ho

ose

s

this

pro

du

ctio

n a

nd

co

nsu

mptio

n.

Co

pyrig

ht©

2003 S

ou

thw

este

rn/T

ho

mso

n L

earn

ing

Page 6: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Fig

ure

1 T

he P

roductio

n P

ossib

ilities C

urve

Co

pyrig

ht©

2003 S

ou

thw

este

rn/T

ho

mso

n L

earn

ing

Po

tato

es

(ou

nc

es

)

12

24

B

0

Me

at (o

un

ce

s)

(b) T

he

Ra

nc

he

r’s

Pro

du

ctio

n P

os

sib

ilities

Fro

ntie

r

48

24

If the

re is

no

trad

e,

the

ran

ch

er c

ho

ose

s

this

pro

du

ctio

n a

nd

co

nsu

mptio

n.

The fa

rmer s

hould

pro

duce p

ota

toes.

The ra

ncher s

hould

pro

duce m

eat.

Specia

lizatio

n a

nd T

rade

•T

he F

arm

er a

nd th

e R

ancher S

pecia

lize a

nd T

rade

•E

ach

wo

uld

be

be

tter o

ff if the

y s

pe

cia

lize

d in

pro

du

cin

g th

e

pro

du

ct th

ey a

re m

ore

su

ited

to p

rod

uce

, an

d th

en

trad

e w

ith e

ach

o

the

r.

Page 7: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Table

2 T

he G

ain

s from

Tra

de

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

Fig

ure

2 H

ow

Tra

de E

xpands th

e S

et o

f Consu

mptio

n

Opportu

nitie

s

Co

pyrig

ht©

2003 S

ou

thw

este

rn/T

ho

mso

n L

earn

ing

Po

tato

es

(ou

nc

es

)

4

16

5

17

8

32

A

A*

0

Me

at (o

un

ce

s)

(a) T

he

Fa

rme

r’s P

rod

uc

tion

an

d C

on

su

mp

tion

Fa

rme

r's

pro

du

ctio

n a

nd

co

nsu

mptio

n

with

ou

t trad

e

Fa

rme

r's

co

nsu

mptio

n

with

trad

e

Fa

rme

r's

pro

du

ctio

n

with

trad

e

Page 8: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Fig

ure

2 H

ow

Tra

de E

xpands th

e S

et o

f Consu

mptio

n

Opportu

nitie

s

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

Po

tato

es

(ou

nc

es

)

12

24

13

27

B

0

Me

at (o

un

ce

s)

(b) T

he

Ra

nc

he

r’s P

rod

uc

tion

an

d C

on

su

mp

tion

48

24

12

18

B* R

an

ch

er's

co

nsu

mptio

n

with

trad

e

Ra

nch

er's

pro

du

ctio

n

with

trad

e

Ra

nch

er's

pro

du

ctio

n a

nd

co

nsu

mptio

n

with

ou

t trad

e

Who c

an p

roduce p

ota

toes a

t a lo

wer

cost--th

e fa

rmer o

r the ra

ncher?

TH

E P

RIN

CIP

LE

OF

CO

MP

AR

AT

IVE

AD

VA

NTA

GE

•D

iffere

nces in

the c

osts

of p

roductio

n d

ete

rmin

e th

e

follo

win

g:

•W

ho

sh

ou

ld p

rod

uce

wh

at?

•H

ow

mu

ch

sh

ou

ld b

e tra

de

d fo

r ea

ch

pro

du

ct?

Page 9: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

TH

E P

RIN

CIP

LE

OF

CO

MP

AR

AT

IVE

AD

VA

NTA

GE

Diffe

rences in

Costs

of P

roductio

n

•Tw

o w

ays to

measure

diffe

rences in

costs

of p

roductio

n:

•T

he

nu

mb

er o

f ho

urs

req

uire

d to

pro

du

ce

a u

nit o

f ou

tpu

t (for

exa

mp

le, o

ne

po

un

d o

f po

tato

es).

•T

he

op

po

rtun

ity c

ost o

f sa

crific

ing

on

e g

oo

d fo

r an

oth

er.

Abso

lute

Adva

nta

ge

•T

he c

om

paris

on a

mong p

roducers

of a

good a

ccord

ing to

their p

roductiv

ity—

ab

so

lute

ad

va

nta

ge

•D

escrib

es th

e p

rod

uctiv

ity o

f on

e p

ers

on

, firm, o

r na

tion

co

mp

are

d

to th

at o

f an

oth

er.

•T

he

pro

du

ce

r tha

t req

uire

s a

sm

alle

r qu

an

tity o

f inp

uts

to p

rod

uce

a

go

od

is s

aid

to h

ave

an

ab

so

lute

ad

va

nta

ge

in p

rod

ucin

g th

at g

oo

d.

Page 10: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

The R

ancher h

as a

n a

bsolu

te a

dvanta

ge in

th

e p

roductio

n o

f both

meat a

nd p

ota

toes.

Abso

lute

Adva

nta

ge

•T

he R

ancher n

eeds o

nly

10 m

inute

s to

pro

duce a

n o

unce

of p

ota

toes, w

here

as th

e F

arm

er n

eeds 1

5 m

inute

s.

•T

he R

ancher n

eeds o

nly

20 m

inute

s to

pro

duce a

n o

unce

of m

eat, w

here

as th

e F

arm

er n

eeds 6

0 m

inute

s.

Opportu

nity C

ost a

nd C

om

para

tive A

dva

nta

ge

•C

om

pare

s p

roducers

of a

good a

ccord

ing to

their

op

po

rtun

ity c

ost.

•W

ha

teve

r mu

st b

e g

ive

n u

p to

ob

tain

so

me

item

•T

he p

roducer w

ho h

as th

e s

malle

r opportu

nity

cost o

f

pro

ducin

g a

good is

said

to h

ave a

co

mp

ara

tive

ad

va

nta

ge

in p

roducin

g th

at g

ood.

Page 11: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Com

para

tive A

dva

nta

ge a

nd T

rade

•W

ho h

as th

e a

bsolu

te a

dvanta

ge?

•T

he fa

rmer o

r the ra

ncher?

•W

ho h

as th

e c

om

para

tive a

dvanta

ge?

•T

he fa

rmer o

r the ra

ncher?

Table

3 T

he O

pportu

nity C

ost o

f Meat a

nd

Pota

toes

Opportu

nity

Cost o

f:

1 o

z o

f Mea

t1 o

z o

f Pota

toes

Farm

er4 o

z potato

es1/4

oz m

eat

Rancher

2 o

z potato

es1/2

oz m

eat

Page 12: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Com

para

tive A

dva

nta

ge a

nd T

rade

•T

he R

ancher’s

opportu

nity

cost o

f an o

unce o

f pota

toes is

¼ a

n o

unce o

f meat, w

here

as th

e F

arm

er’s

opportu

nity

cost o

f an o

unce o

f pota

toes is

½ a

n o

unce o

f meat.

•T

he R

ancher’s

opportu

nity

cost o

f a p

ound o

f meat is

only

4 o

unces o

f pota

toes, w

hile

the F

arm

er’s

opportu

nity

cost

of a

n o

unce o

f meat is

only

2 o

unces o

f pota

toes...

Com

para

tive A

dva

nta

ge a

nd T

rade

…so, th

e R

ancher h

as a

com

para

tive a

dvanta

ge in

the

pro

ductio

n o

f meat b

ut th

e

Farm

er h

as a

com

para

tive

advanta

ge in

the p

roductio

n o

f pota

toes.

Page 13: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Com

para

tive A

dva

nta

ge a

nd T

rade

•C

om

para

tive a

dvanta

ge a

nd d

iffere

nces in

opportu

nity

costs

are

the b

asis

for s

pecia

lized p

roductio

n a

nd tra

de.

•W

henever p

ote

ntia

l tradin

g p

artie

s h

ave d

iffere

nces in

opportu

nity

costs

, they c

an e

ach b

enefit fro

m tra

de.

Com

para

tive A

dva

nta

ge a

nd T

rade

•B

enefits

of T

rade

•T

rad

e c

an

be

ne

fit eve

ryo

ne

in a

so

cie

ty b

eca

use

it allo

ws p

eo

ple

to

sp

ecia

lize

in a

ctiv

ities in

wh

ich

the

y h

ave

a c

om

pa

rativ

e a

dva

nta

ge

.

Page 14: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

FY

I—T

he L

egacy o

f Adam

Sm

ith a

nd

David

Rica

rdo

•A

dam

Sm

ith

•In

his

17

76

bo

ok A

n In

qu

iry in

to th

e N

atu

re a

nd

Ca

use

s o

f the

W

ea

lth o

f Na

tion

s,A

da

m S

mith

pe

rform

ed

a d

eta

iled

an

aly

sis

of

trad

e a

nd

eco

no

mic

inte

rde

pe

nd

en

ce

, wh

ich

eco

no

mis

ts s

till a

dh

ere

to to

da

y.

•D

avid

Ric

ard

o

•In

his

18

16

bo

ok P

rincip

les o

f Po

litica

l Eco

no

my a

nd

Ta

xa

tion

, D

avid

Ric

ard

o d

eve

lop

ed

the

prin

cip

le o

f co

mp

ara

tive

ad

va

nta

ge

a

s w

e k

no

w it to

da

y.

AP

PLIC

AT

ION

S O

F C

OM

PA

RA

TIV

E

AD

VA

NTA

GE

•S

ho

uld

the

Un

ited

Sta

tes T

rad

e w

ith O

the

r

Co

un

tries?

•E

ach

co

un

try h

as m

an

y c

itize

ns w

ith d

iffere

nt

inte

rests

. Inte

rna

tion

al tra

de

ca

n m

ake

so

me

ind

ivid

ua

ls w

ors

e o

ff, eve

n a

s it m

ake

s th

e

co

un

try a

s a

wh

ole

be

tter o

ff.

•Im

po

rts—goods p

roduced a

bro

ad a

nd s

old

dom

estic

ally

•E

xp

orts—

goods p

roduced d

om

estic

ally

and s

old

abro

ad

Page 15: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Sum

mary

•E

ach p

ers

on c

onsum

es g

oods a

nd s

erv

ices p

roduced b

y

many o

ther p

eople

both

in o

ur c

ountry

and a

round th

e

world

.

•In

terd

ependence a

nd tra

de a

re d

esira

ble

because th

ey

allo

w e

very

one to

enjo

y a

gre

ate

r quantity

and v

arie

ty o

f

goods a

nd s

erv

ices.

Sum

mary

•T

here

are

two w

ays to

com

pare

the a

bility

of tw

o p

eople

pro

ducin

g a

good.

•T

he

pe

rso

n w

ho

ca

n p

rod

uce

a g

oo

d w

ith a

sm

alle

r qu

an

tity o

f in

pu

ts h

as a

n a

bso

lute

ad

va

nta

ge

.

•T

he

pe

rso

n w

ith a

sm

alle

r op

po

rtun

ity c

ost h

as a

co

mp

ara

tive

a

dva

nta

ge

.

Page 16: Consider your typical day: Interdependence and the Gains ... · Interdependence and the Gains from Trade • Remember, economics is the study of how societies produce and distribute

Sum

mary

•T

he g

ain

s fro

m tra

de a

re b

ased o

n c

om

para

tive

advanta

ge, n

ot a

bsolu

te a

dvanta

ge.

•T

rade m

akes e

very

one b

ette

r off b

ecause it a

llow

s p

eople

to s

pecia

lize in

those a

ctiv

ities in

whic

h th

ey h

ave a

com

para

tive a

dvanta

ge.

•T

he p

rincip

le o

f com

para

tive a

dvanta

ge a

pplie

s to

countrie

s a

s w

ell a

s p

eople

.


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