Chapter 3 Interdependence and the Gains from Trade PDF

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition 3 CHAPTER Interdependence and the Gains from Trade...

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition 3 CHAPTER Interdependence and the Gains from Trade PowerPoint Slides prepared by: V. Andreea CHIRITESCU Eastern Illinois University © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 1 management system for classroom use.  A Parable for the Modern Economy Only two goods – Meat – Potatoes Only two people – A cattle rancher named Ruby – A potato farmer named Frank – Both would like to eat both meat and potatoes © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 2 management system for classroom use.  A Parable for the Modern Economy If Ruby produces only meat and Frank produces only potatoes – Both gain from trade If both Ruby and Frank produce both meat and potatoes – Both gain from specialization and trade Production possibilities frontier – Various mixes of output that an economy can produce © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 3 management system for classroom use.  Figure 1 The Production Possibilities Frontier (a) Panel (a) shows the production opportunities available to Frank the farmer and Ruby the rancher. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 4 management system for classroom use.  Figure 1 The Production Possibilities Frontier (b, c) (b) Frank’s production (c) Ruby’s production possibilities frontier possibilities frontier Meat (oz) Meat (oz) If there is no trade, Frank If there is no trade, Ruby chooses this production and 24 chooses this production and consumption. consumption. 8 12 B 4 A 0 16 32 0 24 48 Potatoes (oz) Potatoes (oz) Panel (b) shows the combinations of meat and potatoes that Frank can produce. Panel (c) shows the combinations of meat and potatoes that Ruby can produce. Both production possibilities frontiers are derived assuming that Frank and Ruby each work 8 hours per day. If there is no trade, each person’s production possibilities frontier is also his or her consumption possibilities frontier. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 5 management system for classroom use.  A Parable for the Modern Economy Specialization and trade – Farmer Frank specializes in growing potatoes More time growing potatoes Less time raising cattle – Rancher Ruby specializes in raising cattle More time raising cattle Less time growing potatoes – Trade: 5 oz of meat for 15 oz of potatoes © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 6 management system for classroom use.  Figure 2 How Trade Expands the Set of Consumption Opportunities (a,b) (a) Frank’s production (b) Ruby’s production and consumption and consumption Meat (oz) Meat (oz) Frank's production Ruby’s production Ruby’s and consumption with trade production and 24 without trade consumption 18 without trade Frank's 8 consumption Ruby’s with trade 13 B* A* 12 consumption 5 Frank's B with trade 4 production A with trade 0 16 17 32 0 12 24 27 48 Potatoes (oz) Potatoes (oz) The proposed trade between Frank the farmer and Ruby the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade. In panel (a), Frank gets to consume at point A* rather than point A. In panel (b), Ruby gets to consume at point B* rather than point B. Trade allows each to consume more meat and more potatoes. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 7 management system for classroom use.  Figure 2 How Trade Expands the Set of Consumption Opportunities (c) © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 8 management system for classroom use.  Comparative Advantage Absolute advantage – The ability to produce a good using fewer inputs than another producer – In producing meat: Ruby Ruby needs 20 min. to produce 1 oz of meat Frank needs 60 minutes – In producing potatoes: Ruby Ruby needs 10 min. to produce 1 oz of potatoes Frank needs 15 minutes © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 9 management system for classroom use.  Comparative Advantage Opportunity cost – Whatever must be given up to obtain some item – Measures the trade-off between the two goods that each producer faces © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 10 management system for classroom use.  Comparative Advantage Opportunity cost – Frank: 60 min. to produce 1 oz meat, and 15 min. to produce 1 oz potatoes To produce 1 more oz meat, give up 4 oz potatoes To produce 1 more oz potatoes, give up ¼ oz meat – Ruby: 20 min. to produce 1 oz meat, and 10 min. to produce 1 oz potatoes To produce 1 more oz meat, give up 2 oz potatoes To produce 1 more oz potatoes, give up ½ oz meat © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 11 management system for classroom use.  Table 1 The Opportunity Cost of Meat and Potatoes © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 12 management system for classroom use.  Comparative Advantage Comparative advantage – The ability to produce a good at a lower opportunity cost than another producer – Reflects the relative opportunity cost Principle of comparative advantage Each good should be produced by the individual that has the smaller opportunity cost of producing that good – Specialize according to comparative advantage © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 13 management system for classroom use.  Comparative Advantage One person – Can have absolute advantage in both goods – Cannot have comparative advantage in both goods For different opportunity costs – One person has comparative advantage in one good – The other person has comparative advantage in the other good © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 14 management system for classroom use.  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 is better off © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 15 management system for classroom use.  Comparative Advantage Trade can benefit everyone in society – Allows people to specialize in activities in which they have a comparative advantage The price of trade – Must lie between the two opportunity costs The principle of comparative advantage explains: – Interdependence – Gains from trade © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 16 management system for classroom use.