chapter 03_interdependence & gains from trade

7/26/2019 Chapter 03_Interdependence & Gains From Trade

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PowerPoint Slides prepared by:Andreea CHIRITESCUEastern Illinois University

Interdependence and

the Gains fro Trade

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A Parable for the (odern Econoy

- .nly two %oods

/ (eat

/ Potatoes

- .nly two people/ Rancher

/ 0arer

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- If rancher prod*ces only eat

/And farer prod*ces only potatoes

/ 1oth %ain fro trade

- If both rancher and farer prod*ce botheat and potatoes

/ 1oth %ain fro speciali2ation and trade

- Prod*ction possibilities frontier/ 3ario*s i+es of o*tp*t that an econoy

can prod*ce

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0i%*re !


The Prod*ction Possibilities 0rontier 6a7

Panel 6a7 shows the prod*ction opport*nities available to the farer and the rancher'


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0i%*re !


The Prod*ction Possibilities 0rontier 6b) c7

Panel 6b7 shows the cobinations of eat and potatoes that the farer can prod*ce' Panel 6c7shows the cobinations of eat and potatoes that the rancher can prod*ce' 1oth prod*ctionpossibilities frontiers are derived ass*in% that the farer and rancher each wor9 ho*rs perday' If there is no trade) each person;s prod*ction possibilities frontier is also his or her

cons*ption possibilities frontier'

6b7 The farer;s prod*ction

possibilities frontier

6c7 The rancher;s prod*ction

possibilities frontier

(eat 6o27

$

5

Potatoes 6o27

!< 4#

A

If there is no trade) the farerchooses this prod*ction andcons*ption'

(eat 6o27

$

!#

#5

Potatoes 6o27

#5 5

1

If there is no trade) therancher chooses thisprod*ction and cons*ption'


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- Speciali2ation and trade

/ 0arer / speciali2e in %rowin% potatoes- (ore tie %rowin% potatoes

-&ess tie raisin% cattle

/ Rancher / speciali2e in raisin% cattle- (ore tie raisin% cattle

-&ess tie %rowin% potatoes

/ Trade: 8 o2 of eat for !8 o2 of potatoes

/ 1oth %ain fro speciali2ation and trade


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0i%*re #

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How Trade E+pands the Set of Cons*ption .pport*nities 6a) b7

The proposed trade between the farer and the rancher offers each of the a cobination ofeat and potatoes that wo*ld be ipossible in the absence of trade' In panel 6a7) the farer %etsto cons*e at point A> rather than point A' In panel 6b7) the rancher %ets to cons*e at point 1>

rather than point 1' Trade allows each to cons*e ore eat and ore potatoes'

6a7 The farer;s prod*ction

and cons*ption

6b7 The rancher;s prod*ction

and cons*ption

(eat 6o27

$

5

Potatoes 6o27

!< 4#

A

0arer?s prod*ctionand cons*ptionwitho*t trade

(eat 6o27

$

!#

#5

Potatoes 6o27

#5 5

1

Rancher;sprod*ction andcons*ptionwitho*t trade

0arer?sprod*ctionwith trade

8

!=

A>

0arer?s

cons*ptionwith trade !4

!

!# #=

1> Rancher;scons*ptionwith trade

Rancher;s prod*ctionwith trade


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0i%*re #

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How Trade E+pands the Set of Cons*ption .pport*nities 6c7

The proposed trade between the farer and the rancher offers each of the acobination of eat and potatoes that wo*ld be ipossible in the absence of trade' Inpanel 6a7) the farer %ets to cons*e at point A> rather than point A' In panel 6b7) therancher %ets to cons*e at point 1> rather than point 1' Trade allows each to cons*eore eat and ore potatoes'


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Coparative Advanta%e

- Absol*te advanta%e

/ Prod*ce a %ood *sin% fewer inp*ts thananother prod*cer

- .pport*nity cost/ @hatever *st be %iven *p to obtain

soe ite

/ (eas*res the trade,off between the two%oods that each prod*cer faces

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Table !

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The .pport*nity Cost of (eat and Potatoes


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- Coparative advanta%e

/ Prod*ce a %ood at a lower opport*nitycost than another prod*cer

/ Reflects the relative opport*nity cost- Principle of coparative advanta%e

/ Each %ood , prod*ced by the individ*al

that has the saller opport*nity cost ofprod*cin% that %ood

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- .ne person

/ Can have absol*te advanta%e in both%oods

/ Cannot have coparative advanta%e inboth %oods

- 0or different opport*nity costs

/.ne person , coparative advanta%e inone %ood

/ The other person , coparative advanta%ein the other %ood

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- .pport*nity cost of one %ood

/ Inverse of the opport*nity cost of the other

- Gains fro speciali2ation and trade

/ 1ased on coparative advanta%e/ Total prod*ction in econoy rises

- Increase in the si2e of the econoic pie

- Everyone / better off

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- Trade can benefit everyone in society

/Allows people to speciali2e

- The price of trade

/ (*st lie between the two opport*nitycosts

- Principle of coparative advanta%e

e+plains:/ Interdependence

/ Gains fro trade



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Applications of Coparative Advanta%e

- Sho*ld To 1rady (ow His .wn &awnB

- 1rady) in # ho*rs

/ (ow his lawn) or

/ 0il a T3 coercial) earn #$)$$$- 0orest G*p) in 5 ho*rs

/ (ow 1rady;s lawn

/ @or9 at (cDonald;s) earn 5$



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- Sho*ld the U'S' trade with otherco*ntriesB

- Iports

/ Goods prod*ced abroad and solddoestically

- E+ports

/ Goods prod*ced doestically and soldabroad

!


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- Sho*ld the U'S' trade with otherco*ntriesB

/ U'S and apan- Each prod*ces food and cars

- .ne Aerican wor9er) one onth/ .ne car) or

/ Two tons of food

- .ne apanese wor9er) one onth/ .ne car

/ .ne ton of food

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- Principle of coparative advanta%e

/ Each %ood / prod*ced by the co*ntry withthe saller opport*nity cost of prod*cin%that %ood

- Speciali2ation and trade

/All co*ntries have ore food and ore

cars

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chapter 03_interdependence & gains from trade

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