3 Interdependence

7/23/2019 3 Interdependence

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Copyright © 2004 South-Western/Thomson Learning

33Interdependence and

the Gains rom Trade



Copyright © 2004 South-Western

• 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.




• . . . and you a&en(t been up for more tan two

ours yet)




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.





• ,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.





• /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-





• 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.




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-



Ta!"e # The Prod$ction Opport$nities of the Farmerand Rancher



http://slidepdf.com/reader/full/3-interdependence 10/34Copyright © 2004 South-Western

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.



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.

Copyright©2003 South)estern/Thomson Learning



Fi%$re # The Prod$ction Possi!i"ities C$r&e


!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.



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.



Ta!"e + The Gains from Trade1 A /$mmar2




Fi%$re + Ho3 Trade E4pands the /et of Cons$mptionOpport$nities


!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



Fi%$re + Ho3 Trade E4pands the /et of Cons$mptionOpport$nities


!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



Ta!"e + The Gains from Trade1 A /$mmar2




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-



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.



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.



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.



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.



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-



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




• "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...



=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&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.





• 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.




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.




APPLICATION/ OF COMPARATI<E AD<ANTAGE

?? ?

• 3ould "iger oods Eow ,is wn Gawn-




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




/$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.




/$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.



/$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.

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3 Interdependence