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    Mankiw 3

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    Kai Pac
    This document discusses the concept of comparative advantage and how specialization and trade can benefit both parties. It uses the example of a rancher and farmer, showing that while the rancher has an absolute advantage in producing both meat and potatoes, the farmer has a comparative advantage in potatoes because the opportunity cost is lower. Both parties gain if the farmer specializes in potatoes and trades potatoes for the rancher's meat, allowing each to consume more than they could produce alone. The principle of comparative advantage explains how free trade can increase total production and make all parties better off.

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    Mankiw 3

    Uploaded by

    Kai Pac
    81 views15 pages
    This document discusses the concept of comparative advantage and how specialization and trade can benefit both parties. It uses the example of a rancher and farmer, showing that while the rancher has an absolute advantage in producing both meat and potatoes, the farmer has a comparative advantage in potatoes because the opportunity cost is lower. Both parties gain if the farmer specializes in potatoes and trades potatoes for the rancher's meat, allowing each to consume more than they could produce alone. The principle of comparative advantage explains how free trade can increase total production and make all parties better off.

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    mankiw3

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    This document discusses the concept of comparative advantage and how specialization and trade can benefit both parties. It uses the example of a rancher and farmer, showing that while the rancher has an absolute advantage in producing both meat and potatoes, the farmer has a comparative advantage in potatoes because the opportunity cost is lower. Both parties gain if the farmer specializes in potatoes and trades potatoes for the rancher's meat, allowing each to consume more than they could produce alone. The principle of comparative advantage explains how free trade can increase total production and make all parties better off.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    81 views15 pages

    Mankiw 3

    Uploaded by

    Kai Pac
    This document discusses the concept of comparative advantage and how specialization and trade can benefit both parties. It uses the example of a rancher and farmer, showing that while the rancher has an absolute advantage in producing both meat and potatoes, the farmer has a comparative advantage in potatoes because the opportunity cost is lower. Both parties gain if the farmer specializes in potatoes and trades potatoes for the rancher's meat, allowing each to consume more than they could produce alone. The principle of comparative advantage explains how free trade can increase total production and make all parties better off.

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    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 15

    Chapter

    3
    Interdependence and the Gains from Trade

    A Parable for the Modern Economy


    Two goods: meat and potatoes Two people: rancher and farmer If rancher produces only meat
    And farmer produces only potatoes Both gain from trade

    If both rancher and farmer produce both meat and potatoes


    They still gain from specialization and trade
    2

    Figure 1 The production possibilities frontier (a)


    (a) Production Opportunities Minutes needed to Make 1 ounce of: Meat Farmer Rancher 60 min/oz 20 min/oz Potatoes 15 min/oz 10 min/oz Amount produced in 8 hours Meat 8 oz 24 oz Potatoes 32 oz 48 oz

    Panel (a) shows the production opportunities available to the farmer and the rancher.

    Figure 1 The production possibilities frontier (b, c)


    (b) The farmers production Meat (oz) possibilities frontier
    If there is no trade, the farmer chooses this production and consumption.

    (c) The ranchers production Meat (oz) possibilities frontier 24


    If there is no trade, the rancher chooses this production and consumption.

    8 12 4 A

    16

    32

    24

    48

    Potatoes (oz)

    Potatoes (oz)

    Panel (b) shows the combinations of meat and potatoes that the farmer can produce. Panel (c) shows the combinations of meat and potatoes that the rancher can produce. Both production possibilities frontiers are derived assuming that the farmer and rancher each work 8 hours per day. If there is no trade, each persons production possibilities frontier is also his or her consumption possibilities frontier

    A Parable for the Modern Economy


    Specialization and trade
    Farmer specialize in growing potatoes
    More time growing potatoes Less time raising cattle

    Rancher specialize in raising cattle


    More time raising cattle Less time growing potatoes

    Trade
    5 oz of meat for 15 oz of potatoes

    Both gain from specialization and trade


    5

    Figure 2
    How trade expands the set of consumption opportunities (a, b)
    (a) The farmers production Meat (oz) and consumption
    Farmer's production and consumption without trade

    (b) The ranchers production Meat (oz) and consumption 24


    Ranchers production with trade Ranchers production and consumption without trade

    8 A*

    Farmer's consumption with trade

    18 13 12

    B* B
    Ranchers consumption with trade

    5 4

    A 16 17

    Farmer's production with trade

    32

    12

    24 27

    48

    Potatoes (oz)

    Potatoes (oz)

    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.

    Figure 2
    How trade expands the set of consumption opportunities (c)
    (c) The gains from trade: A summary

    Farmer
    Meat Without trade: Production and consumption With trade: Production Trade Consumption GAINS FROM TRADE: Increase in consumption 4 oz 0 oz Gets 5 oz 5 oz +1 oz Potatoes 16 oz 32 oz Gives 15 oz 17 oz +1 oz

    Rancher
    Meat 12 oz Potatoes 24 oz

    18 oz 12 oz Gives 5 oz Gets 15 oz 13 oz 27 oz +1 oz +3 oz

    Comparative Advantage
    Absolute advantage
    Produce a good using fewer inputs than another producer

    Opportunity cost
    Whatever must be given up to obtain some item Measures the trade-off between the two goods that each producer faces

    Table

    The opportunity cost of meat and potatoes


    Opportunity cost of: 1 oz of Meat Farmer Rancher 4 oz potatoes 2 oz potatoes 1 oz of Potatoes oz meat oz meat

    Comparative Advantage
    Comparative advantage
    Produce a good - lower opportunity cost than another producer Reflects - relative opportunity cost

    Principle of comparative advantage


    Each good - produced by the individual that has the smaller opportunity cost of producing that good

    10

    Comparative Advantage
    One person
    Can have absolute advantage in both goods Cannot have comparative advantage in both goods

    For different opportunity costs


    One person - comparative advantage in one good The other person - comparative advantage in the other good
    11

    Comparative Advantage
    Opportunity cost of one good
    Inverse of the opportunity cost of the other

    Gains from specialization and trade


    Based on comparative advantage Total production in economy rises
    Increase in the size of the economic pie Everyone better off

    12

    Comparative Advantage
    Trade can benefit everyone in society
    Allows people to specialize in activities
    Have a comparative advantage

    The price of trade


    Must lie between the two opportunity costs

    Principle of comparative advantage explains:


    Interdependence Gains from trade
    13

    Applications of Comparative Advantage


    Should Tiger Woods mow his own lawn?
    Woods
    Mow his lawn in 2 hours Film a TV commercial and earn $10,000 (2 hours)

    Forrest Gump
    Mow Woodss lawn in 4 hours Work at McDonalds and earn $20 (4 hours)

    14

    Applications of Comparative Advantage


    Should the U.S. trade with other countries?
    Imports
    Goods produced abroad and sold domestically

    Exports
    Goods produced domestically and sold abroad

    Principle of comparative advantage


    Each good produced by the country
    Smaller opportunity cost of producing that good

    Specialization and trade


    All countries greater prosperity
    15

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