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33Interdependence and
the Gains rom Trade
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• Consider your typical day:
• You wake up to an alarm clock made in Korea.
• You pour yourself orange juice made from Florida
oranges and coffee from beans grown in Brazil.
• You put on some clotes made of cotton grown in
!eorgia and sewn in factories in "ailand.
• You watc te morning news broadcast from #ewYork on your "$ made in %apan.
• You dri&e to class in a car made of parts
manufactured in a alf'dozen different countries.
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• . . . and you a&en(t been up for more tan two
ours yet)
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Interdependence and the Gainsfrom Trade
• *emember+ economics is te study of ow
societies produce and distribute goods in an
attempt to satisfy te wants and needs of its
members.
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Interdependence and the Gainsfrom Trade
• ,ow do we satisfy our wants and needs in a
global economy-
• e can be economically self'sufficient.
• e can specialize and tradewit oters+ leading to
economic interdependence.
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Interdependence and the Gainsfrom Trade
• /ndi&iduals and nations rely on specialized
production and e0cange as a way to address
problems caused by scarcity.
• But tis gi&es rise to two 1uestions:
• y is interdependence te norm-
• at determines production and trade-
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Interdependence and the Gainsfrom Trade
• y is interdependence te norm-
• /nterdependence occurs because people are better
off wen tey specialize and trade wit oters.
• at determines te pattern of production andtrade-
• 2atterns of production and trade are based upon
differences in opportunity costs.
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A PARABLE FOR THE MODERNECONOM
• /magine . . .
• only two goods: potatoes and meat
• only two people: a potato farmer and a cattle
rancer
• at sould eac produce-
• y sould tey trade-
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Ta!"e # The Prod$ction Opport$nities of the Farmerand Rancher
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Prod$ction Possi!i"ities
• 3elf'3ufficiency
• By ignoring eac oter:
• 4ac consumes wat tey eac produce.
• "e production possibilities frontier is also te
consumption possibilities frontier.
• itout trade+ economic gains are diminised.
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Fi%$re # The Prod$ction Possi!i"ities C$r&e
!otatoes "ounces#
'
#(
)
*+
A
,
$eat "ounces#
"a# The %armer &s !roduction !ossi'i(ities %rontier
If there is no trade-
the farmer chooses
this prod$ction and
cons$mption.
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Fi%$re # The Prod$ction Possi!i"ities C$r&e
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!otatoes "ounces#
#+
+'
B
,
$eat "ounces#
"'# The *ancher &s !roduction !ossi'i(ities %rontier
')
+'
If there is no trade-
the rancher chooses
this prod$ction and
cons$mption.
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The farmer sho$"d prod$ce
potatoes.
The rancher sho$"d prod$ce meat.
/pecia"i0ation and Trade
• "e Farmer and te *ancer 3pecialize and
"rade
• 4ac would be better off if tey specialized in
producing te product tey are more suited to produce+ and ten trade wit eac oter.
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Ta!"e + The Gains from Trade1 A /$mmar2
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Fi%$re + Ho3 Trade E4pands the /et of Cons$mptionOpport$nities
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!otatoes "ounces#
'
#(
5
#6
)
*+
A
A7
,
$eat "ounces#
"a# The %armer&s !roduction and Consumption
Farmer8s
prod$ction and
cons$mption
3itho$t trade
Farmer8s
cons$mption
3ith trade
Farmer8sprod$ction
3ith trade
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Fi%$re + Ho3 Trade E4pands the /et of Cons$mptionOpport$nities
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!otatoes "ounces#
#+
+'
#*
+6
B
,
$eat "ounces#
"'# The *ancher&s !roduction and Consumption
')
+'
#+
#)
B7
Rancher8s
cons$mption
3ith trade
Rancher8s
prod$ction
3ith trade
Rancher8s
prod$ction and
cons$mption
3itho$t trade
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Ta!"e + The Gains from Trade1 A /$mmar2
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9ho can prod$ce potatoes at a "o3er
cost::the farmer or the rancher;
THE PRINCIPLE OFCOMPARATI<E AD<ANTAGE
• 5ifferences in te costs of production
determine te following:
• o sould produce wat-
• ,ow muc sould be traded for eac product-
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THE PRINCIPLE OFCOMPARATI<E AD<ANTAGE
• 5ifferences in Costs of 2roduction
• "wo ways to measure differences in costs of
production:
• "e number of ours re1uired to produce a unit of
output 6for e0ample+ one pound of potatoes7.
• "e opportunity cost of sacrificing one good for
anoter.
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A!so"$te Ad&anta%e
• "e comparison among producers of a good
according to teir producti&ity8 absolute
advantage
• 5escribes te producti&ity of one person+ firm+ ornation compared to tat of anoter.
• "e producer tat re1uires a smaller 1uantity of
inputs to produce a good is said to a&e an absolute
ad&antage in producing tat good.
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The Rancher has an a!so"$te ad&anta%e in
the prod$ction of !oth meat and potatoes.
A!so"$te Ad&anta%e
• "e *ancer needs only 9 minutes to produce
an ounce of potatoes+ wereas te Farmer needs
9; minutes.
• "e *ancer needs only < minutes to producean ounce of meat+ wereas te Farmer needs =
minutes.
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Opport$nit2 Cost and Comparati&e Ad&anta%e
• Compares producers of a good according to
teir opportunity cost .
• ate&er must be gi&en up to obtain some item
• "e producer wo as te smaller opportunitycost of producing a good is said to a&e a
comparative advantage in producing tat good.
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Comparati&e Ad&anta%e and Trade
• o as te absolute ad&antage-
• "e farmer or te rancer-
• o as te comparati&e ad&antage-
• "e farmer or te rancer-
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Ta!"e * The Opport$nit2 Cost of Meatand Potatoes
Opportunity Cost of:
1 oz of Meat 1 oz of Potatoes
Farmer > oz potatoes 9?> oz meat
Rancher < oz potatoes 9?< oz meat
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Comparati&e Ad&anta%e and Trade
• "e *ancer(s opportunity cost of an ounce of potatoes is @ an ounce of meat+ wereas te
Farmer(s opportunity cost of an ounce of
potatoes is A an ounce of meat.
• "e *ancer(s opportunity cost of a pound of
meat is only > ounces of potatoes+ wile teFarmer(s opportunity cost of an ounce of meat
is only < ounces of potatoes...
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=so- the Rancher has a
comparati&e ad&anta%e in the
prod$ction of meat !$t theFarmer has a comparati&e
ad&anta%e in the prod$ction of
potatoes.
Comparati&e Ad&anta%e and Trade
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Comparati&e Ad&anta%e and Trade
• Comparati&e ad&antage and differences inopportunity costs are te basis for specialized
production and trade.
• ene&er potential trading parties a&edifferences in opportunity costs+ tey can eac
benefit from trade.
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Comparati&e Ad&anta%e and Trade
• Benefits of "rade
• "rade can benefit e&eryone in a society because it
allows people to specialize in acti&ities in wic
tey a&e a comparati&e ad&antage.
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FI>The Le%ac2 of Adam /mithand Da&id Ricardo
• dam 3mit
• /n is 9= book An Inquiry into the Nature and
Causes of the Wealth of Nations, dam 3mit
performed a detailed analysis of trade and economicinterdependence+ wic economists still adere to
today.
• 5a&id *icardo
• /n is 9D9= book Principles of Political Economy
and Taation+ 5a&id *icardo de&eloped te
principle of comparati&e ad&antage as we know it
today.
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APPLICATION/ OF COMPARATI<E AD<ANTAGE
?? ?
• 3ould "iger oods Eow ,is wn Gawn-
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APPLICATION/ OF COMPARATI<E AD<ANTAGE
• 3ould te Hnited 3tates "rade wit ter Countries-
• 4ac country as many citizens wit different
interests. /nternational trade can make someindi&iduals worse off+ e&en as it makes te country as a
wole better off.
• Imports 8goods produced abroad and sold domestically
• Eports 8goods produced domestically and sold abroad
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/$mmar2
• 4ac person consumes goods and ser&ices produced by many oter people bot in our
country and around te world.
• /nterdependence and trade are desirable because tey allow e&eryone to enjoy a greater
1uantity and &ariety of goods and ser&ices.
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/$mmar2
• "ere are two ways to compare te ability oftwo people producing a good.
• "e person wo can produce a good wit a smaller
1uantity of inputs as an absolute ad&antage.• "e person wit a smaller opportunity cost as a
comparati&e ad&antage.
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/$mmar2
• "e gains from trade are based on comparati&ead&antage+ not absolute ad&antage.
• "rade makes e&eryone better off because it
allows people to specialize in tose acti&ities inwic tey a&e a comparati&e ad&antage.
• "e principle of comparati&e ad&antage applies
to countries as well as people.