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ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

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ECON202, Maclachlan, Spri ng 2005 1 Interdependence & Gains from Trade Week 2
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Page 1: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 1

Interdependence & Gains from Trade

Week 2

Page 2: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 2

Principle #5

Trade can make everyone better off.

Page 3: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 3

What’s the alternative to trade?

David Thoreau

at Walden Pond.

Page 4: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 4

Autarky

A policy of national self-sufficiency and nonreliance on imports or economic aid.

Page 5: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 5

Mercantilism

A country should aim to run trade surpluses and increase its monetary assets.

Page 6: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 6

Adam Smith (1723-1790)

Critic of mercantilism.

Countries should specialize and trade.

Specialize where there’s an ABSOLUTE ADVANTAGE

Page 7: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 7

ABSOLUTE ADVANTAGE

A region has an absolute advantage if it takes fewer resources to produce a good there than elsewhere.

Coffee in Columbia.

Computer software in Silicon Valley.

Page 8: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 8

David Ricardo (1772-1823)

Theory of comparative advantage.

Even without an absolute advantage a region can trade to the benefit of all parties.

Page 9: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

Table 1 The Production Opportunities of the Farmer and Rancher

Copyright © 2004 South-Western

Page 10: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 10

Figure 1a The Production Possibilities Frontier

Page 11: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 11

Figure 1b The Production Possibilities Frontier

Page 12: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 12

Rancher’s Deal for Farmer

• Farmer stops producing meat and specializes in potatoes. In a week he can produce …

• 32 oz of potatoes.• Farmer sells 15 oz to Rancher for 5 oz of

meat. Farmer ends up with …• 32 - 15 = 17 oz of potatoes and 5 oz of

meat. Farmer is better off.

Page 13: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 13

Rancher’s Plan

• Spend 6 hrs producing 18 oz of meat.

• Sell 5 oz and keep 13 oz of meat.

• Spend 2 hrs producing 12 oz of potatoes.

• Total potato consumption 15 oz + 12 oz = 27 oz.

• Total consumption: 13 oz of meat and 27 oz of potatoes.

Page 14: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 14

Figure 2a How Trade Expands the Set of Consumption Opportunities

Page 15: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 15

Figure 2b How Trade Expands the Set of Consumption Opportunities

Page 16: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

Table 2 The Gains from Trade: A Summary

Copyright © 2004 South-Western

Page 17: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

ECON202, Maclachlan, Spring 2005 17

How to determine comparative advantage

Look for that good or service for which the OPPORTUNITY COST is lowest.

The opportunity cost is the cost of producing in terms of an alternative good.

Page 18: ECON202, Maclachlan, Spring 20051 Interdependence & Gains from Trade Week 2.

Table 3 The Opportunity Cost of Meat and Potatoes

Copyright © 2004 South-Western


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