Chapter 3: Interdependence and the Gains from Trade
Ch. 3: Interdependence and the Gains from Trade
Chapter 3: Interdependence and the Gains from Trade
Interdependence: every day you rely on many people from
around the world, most of whom you’ve never met, to provide you
with the goods and services you enjoy.
Exports by country
http://www.indexmundi.com/trade/exports/
Chapter 3: Interdependence and the Gains from Trade
Trade can make everyone better off.
The United States and Canada both enjoy using computers and
consuming maple syrup. The United States and Canada both have
the ability to produce each.
What does each country’s production possibilities frontier (PPF)
look like? What about if we allow trade?
Chapter 3: Interdependence and the Gains from Trade
What does the United States’ PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
The United States has 10,000 hours of labor per
month and requires 50 hours to build a computer
and 5 hours to tap a gallon of syrup.
3000
Gallons of
maple 2000
syrup
1000
0
0
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
What does the United States’ PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
The United States has 10,000 hours of labor per
month and requires 50 hours to build a computer
and 5 hours to tap a gallon of syrup.
3000
Gallons of
maple 2000
syrup
1000
0
0
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
What does the United States’ PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
The United States has 10,000 hours of labor per
month and requires 50 hours to build a computer
and 5 hours to tap a gallon of syrup.
3000
Gallons of
maple 2000
syrup
If the United States allocates half
of its labor to computers and half
of its labor to maple syrup, it will
produce 100 computers and 1000
gallons of maple syrup.
1000
0
0
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
What does Canada’s PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
Canada also has 10,000 hours of labor per month
but requires 100 hours to build a computer and 2.5
hours to tap a gallon of syrup.
3000
Gallons of
maple 2000
syrup
1000
0
0
50
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
What does Canada’s PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
Canada also has 10,000 hours of labor per month
but requires 100 hours to build a computer and 2.5
hours to tap a gallon of syrup.
3000
Gallons of
maple 2000
syrup
1000
0
0
50
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
What does Canada’s PPF look like?
United States monthly Production Possibilities
Frontier (PPF) for maple syrup and computers
4000
Canada also has 10,000 hours of labor per month
but requires 100 hours to build a computer and 2.5
hours to tap a gallon of syrup.
3000
If Canada allocates half of its
labor to computers and half of
its labor to maple syrup, it will
produce 50 computers and
2000 gallons of maple syrup.
Gallons of
maple 2000
syrup
1000
0
0
50
100
Number of computers
200
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Absolute advantage: the ability to produce a good using fewer
inputs than another producer.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Absolute advantage: the ability to produce a good using fewer
inputs than another producer.
• USA produces a computer using 50 hours of labor while
Canada uses 100 hours to build a computer: USA has an
absolute advantage over Canada in producing computer.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Absolute advantage: the ability to produce a good using fewer
inputs than another producer.
• USA produces a computer using 50 hours of labor while
Canada uses 100 hours to build a computer: USA has an
absolute advantage over Canada in producing computer.
• Canada produces a gallon of maple syrup using 2.5 hours of
labor while the USA uses 5 hours to produce a gallon of
maple syrup: Canada has an absolute advantage over USA in
producing maple syrup.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Comparative advantage: the ability to produce a good at a lower
opportunity cost than another producer.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Comparative advantage: the ability to produce a good at a lower
opportunity cost than another producer.
• USA: (i) opportunity cost of producing a computer is 10
gallons of maple syrup. (ii) opportunity cost of producing a
gallon of maple syrup is 0.1 computers.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Comparative advantage: the ability to produce a good at a lower
opportunity cost than another producer.
• USA: (i) opportunity cost of producing a computer is 10
gallons of maple syrup. (ii) opportunity cost of producing a
gallon of maple syrup is 0.1 computers.
• Canada: (i) opportunity cost of producing a computer is 40
gallons of maple syrup. (ii) opportunity cost of producing a
gallon of maple syrup is 0.025 computers.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
Comparative advantage: the ability to produce a good at a lower
opportunity cost than another producer.
• USA: (i) opportunity cost of producing a computer is 10
gallons of maple syrup. (ii) opportunity cost of producing a
gallon of maple syrup is 0.1 computers.
• Canada: (i) opportunity cost of producing a computer is 40
gallons of maple syrup. (ii) opportunity cost of producing a
gallon of maple syrup is 0.025 computers.
Canada has a comparative advantage in producing maple
syrup and the USA has a comparative advantage in producing
computers.
Chapter 3: Interdependence and the Gains from Trade
Absolute and comparative advantage.
In this example, the USA has both an absolute and comparative
advantage in producing computers.
In this example, Canada has both an absolute and comparative
advantage in producing maple syrup.
Opportunity cost of:
1 gallon of maple syrup
USA
Canada
1 computer
0.1 computer
10 gallons of maple syrup
0.025 computer
40 gallons of maple syrup
Chapter 3: Interdependence and the Gains from Trade
Trade allows for specialization:
What does the USA-Canada production possibilities frontier
look like if the USA specializes in computers, Canada specializes in
maple syrup and they split the production among themselves?
Chapter 3: Interdependence and the Gains from Trade
4000
United States-Canada production possibilities
frontier (PPF) with trade
Canada specializing
with trade.
Canada produces 4000 gallons of maple syrup
when it specializes in its comparative advantage.
3000
USA produces 200 computers when it specializes
in its comparative advantage.
Gallons of
maple 2000
syrup
1000
0
0
50
100
Number of computers
USA specializing with
trade.
200
Chapter 3: Interdependence and the Gains from Trade
4000
United States-Canada production possibilities
frontier (PPF) with trade
Canada specializing
with trade.
Canada produces 4000 gallons of maple syrup
when it specializes in its comparative advantage.
3000
USA produces 200 computers when it specializes
in its comparative advantage.
Gallons of
maple 2000
syrup
After trading, both the USA and Canada receive
2000 gallons of maple syrup and 100 computers.
Notice this point is beyond the feasible production of either
country (PPF lines) individually.
1000
0
0
50
100
Number of computers
USA specializing with
trade.
200
Chapter 3: Interdependence and the Gains from Trade
USA and Canada PPF’s
(Alternative example: maple syrup and hockey sticks)
4000
The United States and Canada each have 1,000
hours of labor available per month.
It takes the United States 2 hours to produce a
hockey stick and ½ hour to produce a gallon of
syrup.
3000
B
Gallons of
maple 2000
syrup
It takes Canada 30 minutes to make a hockey stick
and 15 minutes to produce a gallon of syrup.
D
Which line represents USA’s PPF?
A
Which line represents Canada’s PPF?
1000
C
0
0
500
1000
Hockey sticks
2000
Chapter 3: Interdependence and the Gains from Trade
USA and Canada PPF’s
(Alternative example: maple syrup and hockey sticks)
4000
What country has an absolute advantage in
producing hockey sticks?
3000
What country has an absolute advantage in
producing maple syrup?
Gallons of
maple 2000
syrup
What country has a comparative advantage in
producing hockey sticks?
What country has a comparative advantage in
producing maple syrup?
1000
0
0
500
1000
Hockey sticks
2000
Chapter 3: Interdependence and the Gains from Trade
• One country may have an absolute advantage over another
country in all forms of production - but there is still a place
for trade and specialization!
Chapter 3: Interdependence and the Gains from Trade
• One country may have an absolute advantage over another
country in all forms of production - but there is still a place
for trade and specialization!
• Gains from trade arise from comparative advantage
(differences in opportunity costs).
Chapter 3: Interdependence and the Gains from Trade
• One country may have an absolute advantage over another
country in all forms of production - but there is still a place
for trade and specialization!
• Gains from trade arise from comparative advantage
(differences in opportunity costs).
• When each country specializes in the good(s) in which it has
a comparative advantage, total production in all countries is
higher, the world’s “economy pie” is bigger, and all countries
can gain from trade.
Chapter 3: Interdependence and the Gains from Trade
• One country may have an absolute advantage over another
country in all forms of production - but there is still a place
for trade and specialization!
• Gains from trade arise from comparative advantage
(differences in opportunity costs).
• When each country specializes in the good(s) in which it has
a comparative advantage, total production in all countries is
higher, the world’s “economy pie” is bigger, and all countries
can gain from trade.
• The same applies to individual producers (like a farmer and a
rancher) specializing in different goods and trading with each
other.