Interdependence+and+the+Gains+from+Trade

=Interdependence and the Gains from Trade = = =

=KEY WORDS=


 * **Absolute advantage:** Producer who can produce a product most efficiently when compared to other producers.
 * **Comparative advantage:** Producer who has the advantage of producing a product at a lower opportunity cost compared to other producers.
 * **Imports:** A product, produced outside of nation, sold domestically.
 * **Exports:** A product, produced domestically, sold outside of nation.
 * **Opportunity cost:** A cost one must give up to gain something. Ex. time, money, etc.

=CONCEPT=

In our society, everyone uses many products that are made from all over the world. This happens due to TRADE which include both imports and exports. To analyze the benefits of trading, we must look at production possibilities frontier graph. Production possibility frontier graph is a concept that describes what a producer can create without any trade and create with trade. For example, a producer can make both cars and computers. However, he cannot produce both at the highest level because the resources and time are limited. Moreover, the ability for the producer to create a car and computer will be different.



Without any trade, no points cannot be outside of the production possibility because it is impossible to create more with a limited amount of resources. Therefore, to go outside of the production frontier, trade must happen.

Trade basically means specialization in products. One group will specialize in producing cars and one group will specialize in producing computers based on their comparative advantage. Here, comparative advantage, not absolute advantage, is the key component because it deals with the opportunity cost. A producer can have absolute advantage in both producing cars and computers, but cannot have both comparative advantage due to the opportunity cost of the products.

Thus, one who has the comparative advantage for that product will specialize the product and trade.

=PROBLEM= Let's imagine that there are two basketball players, Lebron and Kobe, producing shoes and jerseys.




 * Lebron can produce 1000 shoes and 10 jerseys
 * Kobe can produce 10 shoes and 1000 jerseys.
 * Looking at the data, we can see that:
 * Lebron has the comparative advantage in making shoes.
 * Kobe has the comparative advantage in making jerseys.
 * To maximize efficiency within the market, the two basketball players should trade.
 * Lebron should specialize in making shoes.
 * Kobe should specialize in making jerseys.
 * What happens?
 * After their trade, the two have achieved at a point outside the production frontier curve.

= = =Conclusion= = Trade can actually benefit both parties. In order for both parties to benefit, the two parties must look at their comparative advantages and seek to specialize in that product. =