Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
33
WHAT’S NEW IN THE SEVENTH EDITION:
There is a new
In The News
feature on "Economics within a Marriage."
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ how everyone can benefit when people trade with one another.
➢ the meaning of absolute advantage and comparative advantage.
➢ how comparative advantage explains the gains from trade.
➢ how to apply the theory of comparative advantage to everyday life and national policy.
CONTEXT AND PURPOSE:
Chapter 3 is the third chapter in the three-chapter section that serves as the introduction of the text.
Chapter 1 introduced ten fundamental principles of economics. Chapter 2 developed how economists
approach problems. This chapter shows how people and countries gain from trade (which is one of the
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
KEY POINTS:
• Each person consumes goods and services produced by many other people both in the United States
and around the world. Interdependence and trade are desirable because they allow everyone to
enjoy a greater quantity and variety of goods and services.
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
to have a
comparative advantage
. The gains from trade are based on comparative advantage, not
absolute advantage.
• The principle of comparative advantage applies to countries as well as to people. Economists use the
principle of comparative advantage to advocate free trade among countries.
CHAPTER OUTLINE:
I. A Parable for the Modern Economy
A. Example: two goods—meat and potatoes; and two people—a cattle rancher named Rose and a
potato farmer named Frank (each of whom likes to consume both potatoes and meat).
1. The gains from trade are obvious if Frank can only grow potatoes and Rose can only raise
cattle.
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
Meat
Potatoes
Meat
Potatoes
3. The production possibilities frontiers can also be drawn.
a. These production possibilities frontiers are drawn linearly instead of being bowed out.
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
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.
C. Specialization and Trade
1. Suppose Rose suggests that Frank specialize in the production of potatoes and then trade
with her for meat.
a. Rose will spend six hours a day producing meat (18 ounces) and two hours a week
growing potatoes (12 ounces).
2. End results:
a. Rose produces 18 ounces of meat and trades 5 ounces, leaving her with 13 ounces of
meat. She also grows 12 ounces of potatoes and receives 15 ounces in the trade, leaving
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
II. Comparative Advantage: The Driving Force of Specialization
A. Absolute Advantage
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
producing an ounce of potatoes is one-half ounce of meat.
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.
38 ❖ Chapter 3/Interdependence and the Gains from Trade
2. Definition of comparative advantage: the ability to produce a good at a lower
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.
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.
D. The Price of the Trade
1. For both parties to gain from trade, the price at which they trade must lie between the
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
1. In Adam Smith's 1776 book
An Inquiry into the Nature and Causes of the Wealth of Nations,
he writes of the ability of producers to benefit through specialization and trade.
3. The benefits of free trade are an issue that is generally agreed upon by most economists,
and the theories and arguments developed by these two individuals 200 years ago are still
used today.
IV. Applications of Comparative Advantage
A. Should Tom Brady Mow His Own Lawn?
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.
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.
B. Should the United States Trade with Other Countries?
1. Just as individuals can benefit from specialization and trade, so can the populations of
different countries.
2. Definition of imports: goods produced abroad and sold domestically.
C.
In the News: Economics within a Marriage
1. The principles of comparative advantage and gains from specialization and trade even apply
to housework.
2. This article from
Slate
describes the division of housework between the author and her
husband, even though she has the absolute advantage in doing it all..
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. Figure 1 shows Robinson Crusoe’s production possibilities frontier for gathering coconuts and
catching fish. If Crusoe lives by himself, this frontier limits his consumption of coconuts and
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.
Chapter 3/Interdependence and the Gains from Trade ❖ 41
2. Crusoe’s opportunity cost of catching one fish is 10 coconuts, since he can gather 10
Questions for Review
2. Absolute advantage reflects a comparison of the productivity of one person, firm, or nation to
3. Many examples are possible. Suppose, for example, that Roger can prepare a meal of hot
42 ❖ Chapter 3/Interdependence and the Gains from Trade
4. Comparative advantage is more important for trade than absolute advantage. In the example
Quick Check Multiple Choice
Problems and Applications
1. a. See Figure 2. If Maria spends all 5 hours studying economics, she can read 100 pages, so
Chapter 3/Interdependence and the Gains from Trade ❖ 43
2. a.
Workers needed to make:
One Car
One Ton of Grain
b. See Figure 3. With 100 million workers and 4 cars per worker, if either economy were
devoted completely to cars, it could make 400 million cars. Because a U.S. worker can
Figure 3
c. Because a U.S. worker produces either 4 cars or 10 tons of grain, the opportunity cost of
Opportunity Cost of:
One Car (in terms of tons
of grain given up)
One Ton of Grain (in
terms of cars given up)
44 ❖ Chapter 3/Interdependence and the Gains from Trade
d. Neither country has an absolute advantage in producing cars, because they are equally
e. Japan has a comparative advantage in producing cars, because it has a lower
g. From any situation with no trade, in which each country is producing some cars and
some grain, suppose the United States changed one worker from producing cars to
3. a. Pat's opportunity cost of making a pizza is 1/2 gallon of root beer, because she could
brew 1/2 gallon in the time (2 hours) it takes her to make a pizza. Kris's opportunity cost
exchange it for root beer that Kris makes.
c. The highest price of pizza in terms of root beer that will make both roommates better off
Chapter 3/Interdependence and the Gains from Trade ❖ 45
b. See Figure 4. If all 10 million workers produce 2 cars each, they produce a total of 20
million cars, which is the vertical intercept of the production possibilities frontier. If all 10
c. If the United States buys 10 million cars from Canada and Canada continues to consume
10 million cars, then Canada will need to produce a total of 20 million cars. So Canada
5. a. English workers have an absolute advantage over Scottish workers in producing scones,
because English workers produce more scones per hour (50 vs. 40). Scottish workers
have an absolute advantage over English workers in producing sweaters, because
46 ❖ Chapter 3/Interdependence and the Gains from Trade
b. If England and Scotland decide to trade, Scotland will produce sweaters and trade them
c. Even if a Scottish worker produced just one sweater per hour, the countries would still
b. Boston has an absolute advantage in the production of both types of socks, because a
d. Trade can occur at any price between 1 and 2 pairs of red socks per pair of white socks.
At a price lower than 1 pair of red socks per pair of white socks, Boston will choose to
7. a. Gains from trade will be possible when X does not equal 3. Gains from trade are possible
b. Germany will export cars and import wine for all values of X<3. For Germany to export
cars, it must have the comparative advantage in producing cars and France must have
Chapter 3/Interdependence and the Gains from Trade ❖ 47
8. a. The production possibilities frontiers for the two countries are shown in Figure 5. If,
without trade, a U.S. worker spends half of his time producing each good, the United
b. China would export shirts because it has the lower opportunity cost of shirts. For China,
the opportunity cost of 1 shirt is 1/10 computer. For the United States, the opportunity
c. The price of a computer would fall between 5 and 10 shirts. If the price were below 5,
d. Once the productivity is the same in the two countries, the benefits of trade disappear.
48 ❖ Chapter 3/Interdependence and the Gains from Trade
