Chapter+3+(Interdependence+and+the+Gains+from+Trade)

= **Interdependence and the Gains from Trade** =

Remember the //Ten Principles of Economics// mentioned in Chapter 1?

And one of the ten principle was that trade can make everyone better off. Ever wondered why? Well, this chapter finally explains why trade can make everyone better off.

Lets simplify the world of economy into only two different types of people and one kind of trade.



Imagine, I can only make potatoes and you make only meat. And for our meal, we both like the fries and meat together. This results in trade between you and me, because we both want to eat the two together. In this case, it is obvious that trade benefits both you and me.

But when I can produce potatoes and meat and you can also produce both. Is it necessary for us to trade?

Lets examine it more carefully.

Suppose that I work 5 hours a day. And to make one ounce of meat, I need 60 minutes and to make an ounce of potatoes, I need 15 minutes. As for you, you can make meat in 20 minutes, and you need 10 minutes to make an ounce of potatoes.

In this case, who trades what and why?

The production possiblities frontier is a graph showing the number of production the suppler can make. When they two of us are not trying, it means that the production possibilities frontier is exactly the consumption possibilities frontier.



To be outside (Y) the production possibilities frontier shows that the consumption is more than one can make. But how would you have more consumption than one can make? That is to **trade** !

But in our case it seems like you have more advantage in making both of the food, so why would you trade?

That is true, you have the absolute advantage in both, ptatoes and meat, but do you have the comparative advantage?

**Absolute advantage** is the ability to produce a good using fewer inputs than another prducer.

and

**Comparative advantage** is the ability to produce a good at a lower opportunity cpst than another producer.



The answer is no, you do not have a comparative advantage in meat because in 10 minutes when you have an ounce of patatoes, you can make two ounces of meat.  media type="youtube" key="_WqOHIStMpM&hl=ko&fs=1" height="344" width="425"


 * The opportunity cost** is whatever must be given up to obtain some item.



In this case, 10 minutes making potato must be given up to make the twon ounces of meat.

Opportunity Cost of:
 * ||~  ||~ For 1 ounce of meat: ||||~ For 1 ounce of potato: ||
 * = You ||= 2 oz of potato |||| 1/2 oz of meat ||
 * = Me ||||= 4 oz of potato || 1/4 oz of meat ||

This shows that you have a comparative advantage in producing meat, and I have a comparative advantage in producing potatos. Why? When you make meat, you only lose 2 oz of potatoes while I lose 4. You lose less in producing meat. And when you make potato, you lose 1/2 of a meat while I lose 1/4. Here, I lose less in producing potato.

By having a comparative advantage on a product means that we will benefit the most by spcializing it on that product. This enables us to specialize and be more producive by trading - leading us to have a point on the production possibilities frontier outside of out line. Chapter 3 summery podcast:

media type="file" key="chap. 3 econ.m4a"

Questions:

Which one of the following is a correct definition of opportunity cost? Answer: C
 * || a) || The amount of money that something costs today. ||
 * || b) || The amount of money that something will cost in future. ||
 * || c) || A measure of the cost of something in terms of the alternatives that had to be given up but could have been chosen instead. ||
 * || d) || The amount of time and effort spent in order to enter a competition. ||

The principle of comparative advantage implies that:
 * || a) || By specializing in the production of things that individuals (or nations) are relatively good at and trading with others who specialize in what they are relatively good at, all can become better off. ||
 * || b) || People would be better off if they could acquire a wider range of skills. ||
 * || c) || Skilled people will become better off through trading while unskilled people will become worse off. ||
 * || d) || It is better to do you own plumbing if you earn less than a plumber. ||

Answer: A

A production possibility frontier shows: Answer: B
 * || a) || The minimum amount of products that a nation can produce with its current resource endowment. ||
 * || b) || The maximum combinations of products that a nation can produce with its current resource endowment and current technology. ||
 * || c) || The maximum that a nation can produce with current resources and any past or future technology. ||
 * || d) || The point at which a nation currently produces. ||

Sources: are taged on the items. Textbook: Principles of Microeconomics by N. Gregory Mankiw http://www.oup.com/uk/orc/bin/9780199286416/01student/questions/lipsey_student_ch01/page_01.htm