Chapter+3+Independence+and+the+Gains+from+Trade

=Chapter 3. = =Independence and The Gains From Trade =



=Definitions= absolute advantage: the ability to produce a good using fewer inputs than another producer comparative advantage: the ability to produce a good at a lower opportunity cost than another producer imports: good produced abroad and sold domestically exports: goods produced domestically and sold abroad

=LEARNING OBJECTIVES:= 1. You learn the basics of interdependence and the gains from trade. 2. You understand how to calculate the absolute advantage and the comparative advantage. 3. You understand why trading is good from the economic viewpoint as a whole.

I. Introduction
1. This chapter will be a racy chapter about the benefits and gains from trade. 2. However, before understanding the math behind trade, we need to see what different advantages are. For example, let's say there are two people producing goods. Absolute advantage would be producing more with fewer inputs. What if the person can produce one good in 20 minutes while the other only produces one in 60 minutes? The one that can produce in shorter period of time is considered as having the absolute advantage. 3. On the other hand, comparative advantage is used to compare opportunity costs between two producers. If a person gives up only 1/4 of his ability to produce potatoes to produce 1 meat, then that person has the comparative advantage over the other person, who has to give up 2 of his ability to produce potatoes to produce 1 meat. 4. Usually, you cannot have comparative advantage over both of the goods. 5. Also, if you compare in reverse (how much person will give up the meat for the potato), you only have to take the reciprocal, and there's the answer. 6. The gains from specialization and trade are based not on absolute advantage, but on comparative advantage. 7. Now, let's look at the real table and figure out the trading ratio.

II. Trading Table
1. Please look at the chart below.

1 Meat 1 Potato

Alissa 60 min/ oz 15 min/ oz

Jack 20 min/ oz 10 min/ oz

In this case, Jack has absolute advantage over both of the products. Given one hour, in comparative advantage, Jack has to give up two potatoes to produce one meat, whereas Alissa gives up four potatoes to produce 1 meat. On the other hand, Alissa only gives up 1/4 meat to produce one potato whereas Jack has to give up 1/2 meat to produce one potato. As a result, Jack has comparative advantage in meat whereas Alissa has comparative advantage in potatoes.

Then, let's figure out the trading ratio. For easier calculation, let's say 1 meat: x potatoes. To satisfy Jack, we will ask for more than 2 potatoes whereas we don't ask more than 4 potatoes for Alissa. Then, the trading ratio should be 1 meat for 3 potatoes. Alissa should specialize in her potato, and Jack should specialize in his meat since that's what they're good at.

Now, let's trade and see the outcome.

In 2 hours, Alissa produced 0 meat and produced 8 potatoes. Jack produced 6 meat and 0 potatoes. After trading, Alissa is left with 2 meat and 2 potatoes whereas Jack is left with 4 meat and 6 potatoes. Is the outcome better for everybody? If Alissa and Jack didn't trade, then Alissa couldn't have 2 meat (which takes 2 hours solely), and Jack couldn't have 4 meat and 6 potatoes (since 4 meat and 6 potatoes cost him a total of 140 minutes). As a result, everybody won from the trade due to specialization.

III. Conclusion
In chapters after this, we will examine trade in more detail, with focusing on imports and exports. It will get complicated, but remember the basic thing about trade. We measure with opportunity cost.

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= = =**THANK YOU **=

**Review Questions **


1. Draw the chart and figure out a) how much each participant earns after the trade, b) what the trading ratio is, and c) why this is effective?

Jason takes 15 minutes to produce 1 bottle of water, and 60 minutes to produce one chair. Victor takes 10 minutes to produce 1 bottle of water, and 20 minutes to produce one chair.

Answer

1. Chart is skipped. Trading ratio is 1 chair : 3 water bottle. After trading, both win because they earn more than they can produce.



**Work Cited **
image:http://overflow.umwblogs.org/files/2009/04/free-trade-cartoon.jpg video: http://www.youtube.com/watch?v=sFvX5dt8ufs&feature=related image: http://www.soorganic.com/blog/wp-content/uploads/2009/04/world-fairtrade-day-09.jpg