Chapter 3 Homework The Opportunity Costs Are Constant The Production

33

WHAT’S NEW IN THE SIXTH EDITION:

There are no major changes to this chapter.

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

➢ how everyone can benefit when people trade with one another.

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

KEY POINTS:

• Each person consumes goods and services produced by many other people both in our country 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

CHAPTER OUTLINE:

I. A Parable for the Modern Economy

A. Example: two goods—meat and potatoes; and two people—a cattle rancher and a potato farmer

(each of whom likes to consume both potatoes and meat).

1. The gains from trade are obvious if the farmer can only grow potatoes and the rancher can

only raise cattle.

B. Production Possibilities

1. The farmer and rancher both work eight hours per day and can use this time to grow

potatoes, raise cattle, or both.

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

Farmer

60 min./oz.

15 min./oz.

8/1=8 oz.

8/0.25=32 oz.

Rancher

20 min./oz.

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 the farmer’s and the rancher’s technology for producing meat and

potatoes allows them to switch between producing one good and the other at a constant

rate.

4. We will assume that the farmer and rancher divide their time equally between raising cattle

and growing potatoes.

a. The farmer produces (and consumes) at point A—16 ounces of potatoes and 4 ounces of

meat.

Figure 1

36 ❖ Chapter 3/Interdependence and the Gains from Trade

C. Specialization and Trade

1. Suppose the rancher suggests that the farmer specialize in the production of potatoes and

then trade with the rancher for meat.

a. The rancher will spend six hours a day producing meat (18 ounces) and two hours a

week growing potatoes (12 ounces).

2. End results:

a. The rancher produces 18 ounces of meat and trades 5 ounces, leaving him with 13

ounces of meat. He also grows 12 ounces of potatoes and receives 15 ounces in the

trade, leaving him with 27 ounces of potatoes.

Figure 2

Chapter 3/Interdependence and the Gains from Trade ❖ 37

II. Comparative Advantage: The Driving Force of Specialization

A. Absolute Advantage

B. Opportunity Cost and Comparative Advantage

1. Definition of opportunity cost: whatever must be given up to obtain some item.

a. For the rancher, 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.

Prove to your students that it would take each of them more than eight hours to

produce these quantities on their own.

Table 1

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.

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.

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.

Hannah Montana, “Mascot Love.”

(Season 4, 4:05-5:04.) While unclogging

the sink, Robby (the father) realizes he is late for a meeting. When he decides to hire

a plumber, his son Jackson volunteers to fix the sink for $50. The father agrees, and

he admits he would have paid more. This is a nice short clip for showing comparative

advantage. After the clip, discuss both Robby’s and Jackson’s opportunity costs.

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.

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.

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.

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.

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.

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: The Changing Face of International Trade

1. Technology is rapidly changing the goods and services that are traded across international

borders.

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

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

coconuts in the same amount of time it takes to catch one fish. Friday’s opportunity cost of

3. If the world’s fastest typist happens to be trained in brain surgery, she should hire a

secretary because the secretary will give up less for each hour spent typing. Although the

brain surgeon has an absolute advantage in typing, the secretary has a comparative

advantage in typing because the secretary would have a lower opportunity cost of typing.

Questions for Review

1. The production possibilities frontier will be linear if the opportunity cost of producing a good

2. Absolute advantage reflects a comparison of the productivity of one person, firm, or nation to

that of another, while comparative advantage is based on the relative opportunity costs of

3. Many examples are possible. Suppose, for example, that Roger can prepare a meal of hot

dogs and macaroni in just 10 minutes, while it takes Anita 20 minutes. Also suppose that

42 ❖ Chapter 3/Interdependence and the Gains from Trade

4. Comparative advantage is more important for trade than absolute advantage. In the example

6. A nation will export goods for which it has a comparative advantage because it has a smaller

opportunity cost of producing those goods. As a result, citizens of all nations are able to

consume quantities of goods that are outside their production possibilities frontiers.

Problems and Applications

1. a. See Figure 2. If Maria spends all 5 hours studying economics, she can read 100 pages, so

that is the vertical intercept of the production possibilities frontier. If she spends all 5

hours studying sociology, she can read 250 pages, so that is the horizontal intercept. The

opportunity costs are constant, so the production possibilities frontier is a straight line.

b. It takes Maria 2 hours to read 100 pages of sociology. In that time, she could read 40

pages of economics. So the opportunity cost of 100 pages of sociology is 40 pages of

economics.

2. a.

Workers needed to make:

One Car

One Ton of Grain

U.S.

1/4

1/10

Japan

1/4

1/5

c. Because a U.S. worker produces either 4 cars or 10 tons of grain, the opportunity cost of

one car is 2 1/2 tons of grain, which is 10/4. Because a Japanese worker produces either

4 cars or 5 tons of grain, the opportunity cost of one car is 1 1/4 tons of grain, which is

5/4. Similarly, the U.S. opportunity cost of a ton of grain is 2/5 car (4 divided by 10) and

the Japanese opportunity cost of a ton of grain is 4/5 car. This results in the following

table:

Opportunity Cost of:

One Car (in terms of tons

One Ton of Grain (in

44 ❖ Chapter 3/Interdependence and the Gains from Trade

d. Neither country has an absolute advantage in producing cars, because they are equally

productive (the same output per worker); the United States has an absolute advantage

in producing grain, because it is more productive (greater output per worker).

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

producing grain. That worker would produce 4 fewer cars and 10 additional tons of grain.

Then suppose the United States offers to trade 7 tons of grain to Japan for 4 cars. The

United States will do this because it values 4 cars at 10 tons of grain, so it will be better

off if the trade goes through. Suppose Japan changes one worker from producing grain

to producing cars. That worker would produce 4 more cars and 5 fewer tons of grain.

Japan will take the trade because it values 4 cars at 5 tons of grain, so it will be better

off. With the trade and the change of one worker in both the United States and Japan,

each country gets the same amount of cars as before and both get additional tons of

grain (3 for the United States and 2 for Japan). Thus, by trading and changing their

production, both countries are better off.

b. Because Pat has a comparative advantage in making pizza, she will make pizza and

exchange it for root beer that Kris makes.

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

million workers produce 30 bushels of wheat each, they produce a total of 300 million

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

will be producing at the vertical intercept of the production possibilities frontier.

However, if Canada gets 20 bushels of wheat per car, it will be able to consume 200

million bushels of wheat, along with the 10 million cars. This is shown as point B in the

figure. Canada should accept the deal because it gets the same number of cars and 50

million more bushes of wheat.

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

Scottish workers produce more sweaters per hour (2 vs. 1). Comparative advantage runs

the same way. English workers, who have an opportunity cost of 1/50 sweater per scone

46 ❖ Chapter 3/Interdependence and the Gains from Trade

c. Even if a Scottish worker produced just one sweater per hour, the countries would still

gain from trade, because Scotland would still have a comparative advantage in producing

sweaters. Its opportunity cost for sweaters would be higher than before (40 scones per

sweater, instead of 20 scones per sweater before). But there are still gains from trade

because England has a higher opportunity cost (50 scones per sweater).

6. a. With no trade, 1 pair of white socks trades for 1 pair of red socks in Boston, because

productivity is the same for the two types of socks. The price in Chicago is 2 pairs of red

socks per 1 pair of white socks.

c. If they trade socks, Boston will produce white socks for export, because it has the

comparative advantage in white socks, while Chicago produces red socks for export,

which is Chicago’s comparative advantage.

Chapter 3/Interdependence and the Gains from Trade ❖ 47

7. 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

States will have 50 shirts and 10 computers. If, without trade, a worker in China spends

half of his time producing each good, China will have 50 shirts and 5 computers.

b. For the United States, the opportunity cost of 1 computer is 5 shirts, while the

opportunity cost of a shirt is 1/5 computer. For China, the opportunity cost of 1 computer

is 10 shirts, while the opportunity cost of 1 shirt is 1/10 computer. Therefore, the United

States has a comparative advantage in the production of computers and China has a

comparative advantage in the production of shirts.

c. The price of a computer would fall between 5 and 10 shirts. If the price was below 5, the

United States would not be willing to export computers because the opportunity cost of a

shirt for the United States is 1/5 computer. If the price was greater than 10 shirts, China

would not be willing to import computers because (for China) the opportunity cost of a

computer is 10 shirts.

48 ❖ Chapter 3/Interdependence and the Gains from Trade

8. a. An average worker in Brazil has an absolute advantage in the production of coffee

because he requires less time than an average worker in Peru.

b. An average worker in Peru has a comparative advantage in the production of coffee.

The opportunity cost of each ounce of coffee for the average worker in Peru (1.5 ounces

of soybeans) is lower than the opportunity cost of each ounce of coffee for the average

worker in Brazil (3 ounces of soybeans).

9. a. True; two countries can achieve gains from trade even if one of the countries has an

absolute advantage in the production of all goods. All that is necessary is that each

country have a comparative advantage in some good.

d. False; to be good for both parties, the trade price must lie between the two opportunity

costs.

e. False; trade that makes the country better off can harm certain individuals in the

country. For example, suppose a country has a comparative advantage in producing

wheat and a comparative disadvantage in producing cars. Exporting wheat and importing

cars will benefit the nation as a whole, as it will be able to consume more of both goods.

However, the introduction of trade will likely be harmful to domestic auto workers and

manufacturers.

Chapter 3/Interdependence and the Gains from Trade ❖ 49

11. a. Hillary has an absolute advantage in the production of both goods because she is able to produce