Ch.3.Mankiw.trade.2

8/4/2019 Ch.3.Mankiw.trade.2

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A. P. Economics Chapter 3: Interdependence and the Gains from Trade

1. There is interdependence of all the people of the world because of the huge volume of trade

between virtually all countries every day.

1. People depend on others for goods and services because of specialization. Some people make some

things better than other people but not everything…..thus the need for trade.

TABLE ONE: Production Possibilities of the Farmer and the Rancher

1. A farmer and a rancher work 8 hours a day and raise the same products of cattle and potatoes.

1. The farmer can raise an ounce of potatoes in 15 minutes and an ounce of meat in 60 minutes . This

totals 8 ounces of meat in 8 hours and 32 ounces of potatoes in 8 hours.

3. The rancher can raise one ounce of meat in 20 minutes and one ounce of potatoes in ten minutes or

24 ounces of meat in 8 hours and 48 ounces of potatoes in 8 hours.

1. FIGURE ONE: The PPF of the Farmer and the Rancher

(a) and (b) show the combinations of meat and potatoes the farmer and rancher can produce.

1. If the farmer in (a) devotes all of his time to potatoes he produces 32 oz. and no meat. If he devotes

all of his time to meat he produces 8 oz. of meat and no potatoes. If he divides evenly, he produces 4 oz.

of meat & 16 oz. of potatoes.

1. If the rancher devotes all of his time to meat, or potatoes, he can produce 24 ounces or 48 ounces

respectively of each. If he divides evenly, he produces 12 oz. of meat & 24 oz. of potatoes.3. If both choose to be self-sufficient, the PPF also becomes the CPF, Consumption Possibilities

Frontier.

4. You will recall in Ch. 2 that the PPF was bowed outward because of the variable rate of use of

factors of production

between two products. Here, the farmer’s technology for producing meat & potatoes allow him to switch

between the goods at a constant rate. Whenever the farmer spends 1 hour less producing meat and 1 hour more producing potatoes, he reduces his output of meat by 1 ounce and raises his output of potatoes by 4

ounces, regardless of how much he is already producing. The result is a straight line on the PPF.

© The Gains From Trade: A Summary

Farmer

Rancher

Meat Potatoes Meat

Potatoes



Without Trade:

Production and Consumption 4 oz 16 oz 12 oz

24 oz

With Trade:Production 0 oz 32 oz 18 oz

12 ozTrade Gets 5 oz Gives 15 oz Gives 5 oz Gets

15 oz

Consumption 5 oz 17 oz 13 oz

27 oz

Gains From Trade

Increase in Consumption +1 oz +1 oz +1 oz

+3 oz

FIGURE 2: How Trade Expands the Set of Consumption Opportunities

The proposed trade between the farmer and the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade. In panel (a), the farmer gets

to consume at point A* rather than point A. In panel (b), the rancher gets to consume at point B*rather than point B. Trade allows each to consume more meat and more potatoes.

II. Comparative Advantage: The Driving Force of Specialization

If the rancher is better than the farmer at producing both meat and potatoes, how can the farmer

specialize?The principle of comparative advantage will help answer that question. Which

producer can grow potatoes at a lower cost? This a key to understanding the gains from trade.

A. Absolute Advantage: This is the ability for a nation, firm, or individual to produce more of

a good using fewer inputs than another producer.(1) In the “competition” between the farmer and rancher, time is the essential input to

deciding which has the absolute advantage.

(2) The rancher has the absolute advantage over the farmer because he requires less time

to produce both meat and potatoes. The rancher needs 20 minutes to produce an ounce of meatto 60 minutes for the farmer and 10 minutes to produce an ounce of potatoes to 15 minutes for

the farmer.

(3) The rancher has the lower cost if we measure cost by the quantity of inputs.

B. Opportunity Cost and Comparative Advantage: Another way to quantify producing

potatoes is to measure the opportunity cost, what we give up to get another item. Comparative

advantage is the ability to produce something at a lower opportunity cost than another producer.

(1) Ranchers Opportunity Cost: It takes the rancher 10 minutes to produce 1 ounce of potatoes and 20 minutes to produce 1 ounce of meat. So, the opportunity cost of producing 1

ounce of potatoes is 1/2 ounce of meat.

(2) Farmers Opportunity Cost: Producing 1 ounce of potatoes takes 15 minutes, in 15minutes he can also produce 1/4 ounce of meat. So his opportunity cost is 1/4 ounce of meat to

produce 1 ounce of potatoes.

I. Specialization and Tradea. A rancher and a farmer both produce potatoes and cattle for meat.



b. If the farmer starts growing nothing but potatoes, and stops raising cattle, then trades

part of his potato production for some of the ranchers meat production, the farmer can

consume more of each product…..which is to his advantage, and so can the rancher, alsoto his advantage. Both can

consume more meat and potatoes daily by trading with each other.

c. The farmer produces 4 ounces of meat a day, which he will stop producing, and withthe trade, the farmer will receive 5 ounces from the rancher for a net gain of one ounce of meat

a day. The farmer’s production of potatoes per day, with the trade, is now 32 ounces of

potatoes a day of which 15 ounces is traded to the rancher for the 5 ounces of meat. Thefarmer now has a net gain of 1 ounce a day of both meat, from 4 oz to 5 oz, and potatoes

from 16 to 17, because of the trade.

d. The rancher also gains if he reduces his production of potatoes to 12 from 24, adds 15

ounces from trade with the farmer for a total daily consumption 27 ounces of potatoes from 24ounces, increases his meat production from 12 ounces to 18 ounces, trades 5 ounces to the

farmer for the 15 ounces of potatoes and ends up with a gain of 1 ounce of meat and three

ounces of potatoes.

e. Both parties are better off by specializing and from trading with each other.

TABLE 2 Opportunity Cost of:

1 Ounce of Meat 1 Ounce of Potatoes

Farmer 4 oz potatoes 1/4 oz meat

Rancher 2 oz potatoes 1/2 oz meat

3 The producer who gives up less of other goods to produce Good X has the smaller

opportunity cost of producing Good X and is said to have the comparative advantage of producing it.

3 The farmer has a lower opportunity cost of producing potatoes than the rancher, an ounce of

potatoes only costs the farmer 1/4 ounce of meat but it cost the rancher 1/2 ounce of meat. So,the rancher has a lower opportunity cost of producing meat than the farmer. An ounce of meat

costs the rancher 2 ounces of potatoes and it costs the farmer 4 ounces of potatoes.

3 It is possible for one person to have an absolute advantage in both goods but it is impossiblefor one person to have a comparative advantage in both goods.

3 Unless two people have the same opportunity cost, one person will always have a

comparative advantage in one good and one in the other good.

C. Comparative Advantage and Trade: The gains from specialization and trade are basednot on absolute advantage but on comparative advantage. The total production of a country

increases whenever a person specializes in the production of their comparative advantage. This

makes a country’s economy better off.

C. Trade can benefit everyone in society because it allows people to specialize in activities in

which they have a comparative advantage.

One More Time………..

1. Your little brother’s birthday party is Saturday and so is the Britney Spears concert, you can

only attend one event.

1. Your sisters wedding is Friday, your favorite economics lecturer is speaking at Emory on



Friday and again on Saturday.

In which event that you select from each option are you very likely to have a high

opportunity cost and in which a low opportunity cost……..and why?

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Ch.3.Mankiw.trade.2