31
WHAT’S NEW IN THE EIGHTH EDITION:
There is a new
Ask the Experts
feature on “Trade Between China and the United States.”
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
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.
• 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
3
INTERDEPENDENCE AND THE
GAINS FROM TRADE
32 ❖ Chapter 3/Interdependence and the Gains from Trade
to have a
comparative advantage
. The gains from trade are based on comparative advantage, not
absolute advantage.
• Trade makes everyone better off because it allows people to specialize in those activities in which
they have a comparative 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 Ruby and a
potato farmer named Frank (each of whom likes to consume both potatoes and meat).
B. Production Possibilities
1. Frank and Ruby 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 ❖ 33
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.
Ruby 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.
Figure 1
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
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.
34 ❖ Chapter 3/Interdependence and the Gains from Trade
4. We will assume that Frank and Ruby divide their time equally between raising cattle and
growing potatoes.
C. Specialization and Trade
1. Suppose Ruby suggests that Frank specialize in the production of potatoes and then trade
with her for meat.
a. Ruby will spend six hours a day producing meat (18 ounces) and two hours a week
growing potatoes (12 ounces).
2. End results:
a. Ruby 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.
b. Frank produces 32 ounces of potatoes and trades 15 ounces, leaving him with 17
ounces. He also receives 5 ounces of meat in the trade with Ruby.
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.
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.
Students will ask how this “price” is determined. Explain the range of prices that each
participant would be willing to accept.
Prove to your students that it would take each of them more than eight hours to
produce these quantities on their own.
Figure 2
Chapter 3/Interdependence and the Gains from Trade ❖ 35
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 Ruby, 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.
2. Definition of comparative advantage: the ability to produce a good at a lower
opportunity cost than another producer.
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.
36 ❖ Chapter 3/Interdependence and the Gains from Trade
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
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.
Chapter 3/Interdependence and the Gains from Trade ❖ 37
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 Serena Williams Mow Her Own Lawn?
1. Imagine that Serena can mow her 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.
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.
38 ❖ Chapter 3/Interdependence and the Gains from Trade
B.
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.
C. 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.
D.
Ask the Experts:
Trade Between China and the United States
1. 100 percent of economic expert surveyed agreed that trade with China makes most
Americans better off.
2. 96 percent of economic experts surveyed agreed that some Americans who work in the
production of competing goods are made worse off by trade with China.
To help students reconcile these two survey results, point out that trade makes most
Americans better off and only makes a small group of Americans worse off.
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.
Chapter 3/Interdependence and the Gains from Trade ❖ 39
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. Figure 1 shows Robinson Crusoe’s production possibilities frontier for gathering coconuts and
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
Chapter Quick Quiz
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.
40 ❖ Chapter 3/Interdependence and the Gains from Trade
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
4. Comparative advantage is more important for trade than absolute advantage. In the example
6. Economists oppose policies that restrict trade among nations because trade allows all
Problems and Applications
Chapter 3/Interdependence and the Gains from Trade ❖ 41
Figure 2
2. a.
Workers needed to make:
One Car
One Ton of Grain
U.S.
Japan
42 ❖ Chapter 3/Interdependence and the Gains from Trade
Figure 3
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. Similarly, the U.S. opportunity cost of a ton
of grain is 2/5 car (4 divided by 10). Because a Japanese worker produces either 4 cars
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
opportunity cost in terms of grain given up. The United States has a comparative
f. With half the workers in each country producing each of the goods, the United States
would produce 200 million cars (50 million workers times 4 cars each) and 500 million
Chapter 3/Interdependence and the Gains from Trade ❖ 43
United States will do this because the cost of producing 4 cars in the United States is 10
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
c. The highest price of pizza in terms of root beer that will make both roommates better off
4. a. Because a Canadian worker can make either 2 cars a year or 30 bushels of wheat, the
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
will be producing at the vertical intercept of the production possibilities frontier.
44 ❖ Chapter 3/Interdependence and the Gains from Trade
Figure 4
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
b. If England and Scotland decide to trade, Scotland will produce sweaters and export them
c. Even if a Scottish worker produced just one sweater per hour, the countries would still
6. a. With no trade, 1 pair of white socks trades for 1 pair of red socks in Boston, because
b. Boston has an absolute advantage in the production of both types of socks, because a
Chapter 3/Interdependence and the Gains from Trade ❖ 45
d. Trade can occur at any price between 1 and 2 pairs of red socks per pair of white socks.
7. a. Gains from trade will be possible when X does not equal 3. Gains from trade are possible
when a comparative advantage exists. The opportunity cost of 1 car in Germany is 200
cases of wine (400 hours/2 hours per case of wine). Likewise, the opportunity cost of 1
case of wine in Germany is 1/200 car. When X=3, the opportunity cost of 1 car in France
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
46 ❖ Chapter 3/Interdependence and the Gains from Trade
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. 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
cost of a shirt is 1/5 computer. Therefore, China has a comparative advantage in the
c. The price of a computer would fall between 5 and 10 shirts. If the price were below 5,
Chapter 3/Interdependence and the Gains from Trade ❖ 47
c. False; trades can and do benefit both sides⎯especially trades based on comparative