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.
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
.
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
.
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
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
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.
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
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?
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.
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.
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
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.
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
.
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
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
.
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
.
