33
WHAT’S NEW IN THE SEVENTH EDITION:
There is a new
In The News
feature on “Economics within a Marriage.”
LEARNING OBJECTIVES:
how everyone can benefit when people trade with one another.
the meaning of absolute advantage and comparative advantage.
how to apply the theory of comparative advantage to everyday life and national policy.
CONTEXT AND PURPOSE:
ten principles discussed in Chapter 1).
The purpose of Chapter 3 is to demonstrate how everyone can gain from trade. Trade allows people
to specialize in the production of goods for which they have a comparative advantage and then trade for
goods that other people produce. Because of specialization, total output rises, and through trade we are
all able to share in the bounty. This is as true for countries as it is for individuals. Because everyone can
KEY POINTS:
Each person consumes goods and services produced by many other people both in the United States
3
INTERDEPENDENCE AND THE
GAINS FROM TRADE
34 ❖ Chapter 3/Interdependence and the Gains from Trade
There are two ways to compare the ability of two people to produce a good. The person who can
produce the good with a smaller quantity of inputs is said to have an
absolute advantage
in
producing the good. The person who has the smaller opportunity cost of producing the good is said
absolute advantage.
Trade makes everyone better off because it allows people to specialize in those activities in which
they have a comparative advantage.
CHAPTER OUTLINE:
I. A Parable for the Modern Economy
1. The gains from trade are obvious if Frank can only grow potatoes and Rose can only raise
cattle.
2. The gains from trade are also obvious if, instead, Frank can raise cattle as well as grow
3. The gains from trade are not as clear if either Frank or Rose is better at producing both
potatoes and meat.
B. Production Possibilities
1. Frank and Rose both work eight hours per day and can use this time to grow potatoes, raise
cattle, or both.
2. Figure 1 shows the amount of time each takes to produce one ounce of either good:
Make sure that you write out all of the algebra involved in this example. If you leave
out steps, students will not understand how these calculations are made.
Begin by explaining that there are two basic ways that individuals can satisfy their
wants. The first is to be economically self-sufficient. The second is to specialize in the
production of one thing and then trade with others. With rare exceptions, individuals
and nations tend to rely on specialization and trade. One way to demonstrate this is
to survey the students on their future plans (doctors, lawyers, teachers, etc.). Point
out that they plan to specialize and trade. Ask them why this is optimal.
Chapter 3/Interdependence and the Gains from Trade ❖ 35
Minutes Needed to
Make One Ounce of:
Amount Produced in Eight
Hours
Potatoes
Meat
Potatoes
Frank the farmer
15 min./oz.
8/1=8 oz.
8/0.25=32 oz.
Rose the rancher
10 min./oz.
8/0.33=24 oz.
8/0.16=48 oz.
3. The production possibilities frontiers can also be drawn.
a. These production possibilities frontiers are drawn linearly instead of being bowed out.
This assumes that Frank’s and Rose’s technology for producing meat and potatoes allows
b. As we saw in Chapter 2, these production possibilities frontiers represent the principles of
trade-offs and opportunity costs.
ALTERNATIVE CLASSROOM EXAMPLE:
Martha and Stewart each spend eight hours a day wallpapering and painting:
Hours Needed to Do One Room
Rooms Finished in 40 Hours
Paint
Wallpaper
Paint
Wallpaper
Martha
2 hours/room
8 hours/room
8/2=4 rooms
8/8=1 room
Stewart
4 hours/room
10 hours/room
8/4=2 rooms
8/10=0.8 room
Figure 1
36 ❖ Chapter 3/Interdependence and the Gains from Trade
4. We will assume that Frank and Rose divide their time equally between raising cattle and
growing potatoes.
meat.
b. Rose produces (and consumes) at point B—24 ounces of potatoes and 12 ounces of
meat.
C. Specialization and Trade
1. Suppose Rose suggests that Frank specialize in the production of potatoes and then trade
with her for meat.
growing potatoes (12 ounces).
b. Frank will spend eight hours a day growing potatoes (32 ounces).
2. End results:
her with 27 ounces of potatoes.
3. In both cases, they are able to consume quantities of potatoes and meat after the trade that
they could not reach before the trade.
Students will ask how this “price” is determined. Explain the range of prices that each
participant would be willing to accept.
It is important to take the time to explain how to calculate the
x
– and
y
-intercepts.
Point out that Frank could produce 8 ounces of meat if all of his time is spent on
meat or 32 ounces of potatoes if all of his time is spent on potatoes.
You should emphasize that these production possibilities frontiers represent the
farmer’s and the rancher’s
consumption
possibilities because we are assuming that
there is no trade.
Prove to your students that it would take each of them more than eight hours to
produce these quantities on their own.
Chapter 3/Interdependence and the Gains from Trade ❖ 37
A. Absolute Advantage
1. Definition of absolute advantage: the ability to produce a good using fewer inputs
than another producer does.
2. Rose has an absolute advantage in the production of both potatoes and meat.
B. Opportunity Cost and Comparative Advantage
a. For Rose, it takes ten minutes to produce one ounce of potatoes. Those same ten
minutes could be used to produce one-half ounce of meat. Thus, the opportunity cost of
b. For Frank, it takes 15 minutes to produce one ounce of potatoes. Those same 15
minutes could be used to produce one-fourth ounce of meat. Therefore, the opportunity
cost of producing one ounce of potatoes is one-fourth ounce of meat.
Figure 2
Table 1
Your students may have a hard time comprehending this. Make sure that you go
through these calculations several times and write out every step on the board.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
opportunity cost than another producer.
a. Frank has a lower opportunity cost of producing potatoes and therefore has a
comparative advantage in the production of potatoes.
advantage in the production of meat.
3. Because the opportunity cost of producing one good is the inverse of the opportunity cost of
producing the other, it is impossible for a person to have a comparative advantage in the
production of both goods.
C. Comparative Advantage and Trade
1. When specialization in a good occurs (assuming there is a comparative advantage), total
output will grow.
2. As long as the opportunity cost of producing the goods differs across the two individuals,
both can gain from specialization and trade.
a. Frank buys 5 ounces of meat with 15 ounces of potatoes. This implies that the price of
each ounce of meat is three ounces of potatoes, which is lower than Frank’s opportunity
cost of four ounces of potatoes. Trade is beneficial to Frank.
b. Rose buys 15 ounces of potatoes for 5 ounces of meat. The price of each ounce of
potatoes is one-third ounce of meat. This is lower than Rose’s opportunity cost of one–
half ounce of meat. Trade also benefits Rose.
D. The Price of the Trade
opportunity costs.
2. In our example, Frank and Rose must trade at the rate of between 2 and 4 ounces of
potatoes for each of meat.
Chapter 3/Interdependence and the Gains from Trade ❖ 39
E. FYI: The Legacy of Adam Smith and David Ricardo
he writes of the ability of producers to benefit through specialization and trade.
2. In David Ricardo’s 1817 book
Principles of Political Economy and Taxation,
Ricardo develops
and the theories and arguments developed by these two individuals 200 years ago are still
used today.
IV. Applications of Comparative Advantage
1. Imagine that Brady can mow his lawn faster than anyone else can.
2. This implies that he has an absolute advantage.
Activity 1—Creating Comparative Advantage Examples
Type: In-Class Assignment
Topics: Specialization, interdependence, self-interest, comparative advantage
Materials needed: 3-5 candy bars (or similar items to use as prizes)
Time: 15 minutes (first day), depends on number of groups (second day)
Class limitations: works in any size class
Purpose
This assignment allows students to further explore comparative advantage.
Instructions
Divide the class into groups of three or four to write a comparative advantage problem of
their own. Tell them to make creative, humorous, yet plausible examples.
Give the students fifteen minutes to work on creating their examples at the end of class.
Instruct them to bring a neatly written copy of their examples for the next class when each
group will present its example to the rest of the class. Students should include tables and
figures similar to those used in class.
Let the students vote on which group has the best example and award a small prize to the
group’s members.
Make the examples available to all of the students in the class to use as practice problems for
the exam.
40 ❖ Chapter 3/Interdependence and the Gains from Trade
4. It is likely that someone else would have a lower opportunity cost of mowing Brady’s lawn;
this individual would have a comparative advantage.
5. Both he and the person hired will be better off as long as he pays the individual more than
the individual’s opportunity cost and less than $20,000.
1. Just as individuals can benefit from specialization and trade, so can the populations of
different countries.
3. Definition of exports: goods produced domestically and sold abroad.
5. Through specialization and trade, countries can have more of all goods to consume.
6. Trade issues among nations are more complex. Some individuals can be made worse off
even when the country as a whole is made better off.
C.
In the News: Economics within a Marriage
to housework.
2. This article from
Slate
describes the division of housework between the author and her
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
To help convince students that importing goods is not harmful to a country, ask the
students to devise a way to produce coffee domestically. Point out that it is possible
to grow coffee beans in the United States in enclosed nurseries, but the opportunity
cost of the resources used would be significant.
Discuss how differences in resource endowments can be significant factors in
determining opportunity cost and comparative advantage. Such differences include
climate, soil composition, education and training of the labor force, capital stock, and
infrastructure.