Chapter 3
Interdependence and
the Gains from Trade
Ten Principles of Economics
• Trade can make everyone better off
Parable for the Modern Economy
• Two goods in the world: meat & potatoes;
Two people in the world: rancher & farmer
• Should they trade?
• What if one was better at doing both?
Production Possibilities
• Shows various mixes of output that an
economy can produce
• Linear PPF shows tradeoffs at constant rate
• Table 3-1 & Figure 3-1
Specialization and Trade
• Can they both benefit from trade?
• Trade allows them to consume at point
outside their PPF
Absolute Advantage
• Being able to produce a good with a smaller
quantity of inputs than someone else
Opportunity Cost &
Comparative Advantage
• Opportunity Cost: Whatever must be given up
to obtain some item
- measures the trade-off between 2 goods
• Comparative Advantage: ability to produce a
good at a lower opportunity cost than another
producer
- can have an absolute advantage in both
goods, but not to have comp. adv. in both
Comparative Advantage & Trade
• Gains from specialization & trade are based on
comparative advantage
• When people produce good in which they
have a comp. adv., total production rises in
the economy making everyone better off
Price of Trade
• For both parties to gain from trade, the price
at which they trade must lie between the two
opportunity costs
Applications of Comparative Advantage
• Should US trade with other countries?
• Imports vs. Exports