Principles of Economics

Interdependence
and the Gains
from Trade
罗凯
1. A Parable for the Modern
Economy
why people choose to depend on others for
goods and services and how this choice
improves their lives?

Imagine that there are only two goods in the world: meat
and potatoes. And there are only two people: a cattle
rancher named Ruby and a potato farmer named Frank.
Both Ruby and Frank would like to eat a diet of both meat
and potatoes.
 The gains from trade are clearest if Ruby can produce
only meat and Frank can produce only potatoes. It is
easy to see that trade would allow both of them to enjoy
greater variety: Each could then have a steak with a
baked potato or a burger with fries.
 the gains would be similar if Frank and Ruby were each
capable of producing the other good, but only at great
cost. In this case, Frank and Ruby each benefit by
specializing in what he or she does best and then trading
with the other person.
 The gains from trade are less obvious, however, when
one person is better at producing every good. In this
case, should Ruby remain self-sufficient? Or is there still
reason for her to trade with Frank?
1. Production Possibilities
 Suppose that Frank and Ruby each work 8 hours per day and can devote this time to growing potatoes,
raising cattle, or a combination of the two. The following table shows the amount of time each person
requires to produce 1 ounce of each. The last two columns in the table show the amounts of meat or
potatoes Frank and Ruby can produce if they devote all 8 hours to producing only that good.
 Panel (b) illustrates the amounts of meat and potatoes that Frank can
produce.
 Panel (c) shows Ruby’s production possibilities frontier.
 If Frank and Ruby choose to be self-sufficient rather than trade with each other,
then each consumes exactly what he or she produces. In this case, the production
possibilities frontier is also the consumption possibilities frontier.
 These production possibilities frontiers are useful in showing the trade-offs that
Frank and Ruby face, but they do not tell us what each will choose to do. To
determine their choices, we need to know something about their tastes. Let’s
suppose that Frank and Ruby choose the combinations identified by points A and
B in the Figure.
2. Specialization and Trade
 Ruby made a proposal, and 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.

 Frank gets to
consume at
point A*
rather than
point A.
 ruby gets to consume at point B* rather than point B.
 trade allows each to consume more meat and more potatoes.
QuickQui
z 1. Before Frank and ruby engage in trade, each of them.


a. consumes at a point inside his or her production possibilities frontier.

b. consumes at a point on his or her production possibilities frontier.
c. consumes at a point outside his or her production possibilities frontier.
d. consumes the same amounts of meat and potatoes as the other.

 2. After Frank and ruby engage in trade, each of them

 a. consumes at a point inside his or her production possibilities frontier.
 consumes at a point on his or her production possibilities frontier.
 consumes at a point outside his or her production possibilities frontier.
 consumes the same amounts of meat and potatoes as the other.
2. Comparative Advantage: The
Driving Force of
Specialization
If Ruby is better at both raising cattle and growing
potatoes, how can Frank ever specialize
in doing what he does best?

Who can produce potatoes at a lower cost—Frank

or Ruby? There are two possible answers.
1. Absolute Advantage
 One way to answer the question about the cost of producing potatoes is
to compare the inputs required by the two producers. The producer that
requires a smaller quantity of inputs to produce a good is said to have an
absolute advantage in producing that good.
 In our example, time is the only input, so we can determine absolute
advantage by looking at how much time each type of production takes.
Ruby has an absolute advantage in producing both meat and potatoes.
2. Opportunity Cost and Comparative Advantage
 There is another way to look at the cost of producing potatoes. Rather than
comparing inputs required, we can compare opportunity costs.
 Ruby’s opportunity cost of producing 1 ounce of potatoes is ½ ounce of meat.
Frank’s opportunity cost of producing 1 ounce of potatoes is ¼ ounce of meat.
 Notice that the opportunity cost of meat is the inverse of the opportunity cost of
potatoes. Because 1 ounce of potatoes costs Ruby ½ ounce of meat, 1 ounce of
meat costs her 2 ounces of potatoes. Similarly, because 1 ounce of potatoes
costs Frank¼ ounce of meat, 1 ounce of meat costs him 4 ounces of potatoes.
2. Opportunity Cost and Comparative Advantage
 The producer who gives up less of other goods to produce Good X has the
smaller opportunity cost of producing Good X and is said to have a comparative
advantage in producing it.
 In our example, Frank has a lower opportunity cost of producing potatoes than
Ruby. Frank has a comparative advantage in growing potatoes, and Ruby has a
comparative advantage in producing meat.
 Although it is possible for one person to have an absolute advantage in both
goods (as Ruby does in our example), it is impossible for one person to have a
comparative advantage in both goods. Because the opportunity cost of one good
is the inverse of the opportunity cost of the other.
 Comparative advantage reflects the relative opportunity cost. Unless two people
have the same opportunity cost, one person will have a comparative advantage
in one good, and the other person will have a comparative advantage in the other
good.
3. Comparative Advantage and Trade
 The gains from specialization and trade are based not on absolute
advantage but on comparative advantage. When each person
specializes in producing the good in which he or she has a comparative
advantage, total production in the economy rises. This increase in the
size of the economic pie can be used to make everyone better off.
 The total production of potatoes rises from 40 to 44 ounces, and the
total production of meat rises from 16 to 18 ounces.
 We can also view the gains from trade in terms of the price that each
party pays the other. Because Frank and Ruby have different
opportunity costs, they can both get a bargain. That is, each of them
benefits from trade by obtaining a good at a price that is lower than
his or her opportunity cost of that good.

Frank Ruby
Potatoes/Meat Meat/Potatoes
Opportunity cost 4 1/2
Trade price 3 1/3
 Frank buys each ounce of meat for a price of 3 ounces of potatoes. His opportunity
cost of an ounce of meat is 4 ounces of potatoes.
 Ruby gets 15 ounces of potatoes in exchange for 5 ounces of meat. That is, the
price of an ounce of potatoes is 1/3 ounce of meat. This price of potatoes is lower
than her opportunity cost of an ounce of potatoes, which is ½ ounce of meat.
 Trade can benefit everyone in society because it allows people to
specialize in the activities in which they have a comparative advantage.

Meat Potatoes
Frank Ruby Frank Ruby
Without trade:
Production 4 12 16 24
Total 16 40
With trade:
Production 0 18 32 12
Total 18 44

Frank Ruby
Potatoes/Meat Meat/Potatoes
Opportunity cost 4 1/2
Trade price 3 1/3
4. The Price of the Trade
 The principle of comparative advantage establishes that there are gains from
specialization and trade, but it raises a couple of related questions: What
determines the price at which trade takes place? The precise answers to
these questions are beyond the scope of this chapter, but we can state one
general rule: For both parties to gain from trade, the price at which they
trade must lie between their opportunity costs.
 In our example, Frank and Ruby agreed to trade at a rate of 3 ounces of
potatoes for each ounce of meat. This price is between Ruby’s opportunity
cost (2 ounces of potatoes per ounce of meat) and Frank’s opportunity cost
(4 ounces of potatoes per ounce of meat).
 If the price of meat were below 2 ounces of potatoes, both Frank and Ruby
would want to buy meat, because the price would be below each of their
opportunity costs. Similarly, if the price of meat were above 4 ounces of
potatoes, both would want to sell meat, because the price would be above
their opportunity costs. But this economy has only two people. They cannot
both be buyers of meat, nor can they both be sellers. Someone has to take
the other side of the deal.
 The Legacy of Adam
Smith
 It is a maxim of every prudent master of a
and David Ricardo
family, never to attempt to make at home
what it will cost him more to make than to
buy. The tailor does not attempt to make his
own shoes, but buys them of the shoemaker.
The shoemaker does not attempt to make
his own clothes but employs a tailor. The
farmer to make neither the one nor the other, but employs
attempts
those different artificers. All of them find it for their interest to
employ their whole industry in a way in which they have some
advantage over their neighbors, and to purchase with a part of
its produce, or what is the same thing, with the price of part of it,
whatever else they have occasion for.
 Smith’s book inspired David Ricardo, a millionaire stockbroker, to
become an economist. In his 1817 book On the Principles of Political
Economy and Taxation, Ricardo developed the principle of comparative
advantage as we know it today.
QuickQui
z wash
 3. in an hour, Mateo can wash 2 cars or mow 1 lawn, and Sophia can
3 cars or mow 1 lawn. Who has the absolute advantage in car
washing, and who has the absolute advantage in lawn mowing?
 Mateo in washing, Sophia in mowing
 Sophia in washing, Mateo in mowing
 Mateo in washing, neither in mowing
 Sophia in washing, neither in mowing

 4. Between Mateo and Sophia, who has the comparative advantage in

car washing, and who has the comparative advantage in lawn mowing?
 a. Mateo in washing, Sophia in mowing
 Sophia in washing, Mateo in mowing
 Mateo in washing, neither in mowing
 Sophia in washing, neither in mowing.
 5. When Mateo and Sophia produce efficiently and make a mutually
beneficial trade based on comparative advantage,
a. Mateo mows more and Sophia washes more.
b. Mateo washes more and Sophia mows more.
c. Mateo and Sophia both wash more.
d. Mateo and Sophia both mow more Sophia in washing, neither in
mowing.
3. Applications of Comparative
1. Advantage
Should LeBron James Mow His Own Lawn?
 Let’s imagine that LeBron can mow his lawn faster than
anyone else. But just because he can mow his lawn fast,
does this mean he should?
 Let’s say that LeBron can mow his lawn in 2 hours. In
those same 2 hours, he could film a television commercial
and earn $30,000. By contrast, Kaitlyn, the girl next door,
can mow LeBron’s lawn in 4 hours. In those same 4
hours, Kaitlyn could work at McDonald’s and earn $50.
 LeBron has an absolute advantage in mowing lawns, but
Kaitlyn has a comparative advantage in mowing lawns.
 The gains from trade here are tremendous. As long as
LeBron pays Kaitlyn more than $50 and less than
$30,000, both of them are better off.
2. Should the United States Trade with Other
Countries?
 An American worker and a Japanese worker can each produce one car per
month. By contrast, because the United States has more fertile land, it is
better at producing food: A U.S. worker can produce 2 tons of food per month,
whereas a Japanese worker can produce only 1 ton of food per month.
 The United States should produce more food than it wants to consume and
export some to Japan. Through specialization and trade, both countries can
enjoy more food and more cars.
 Goods produced abroad and sold domestically are called imports. Goods
produced domestically and sold abroad are called exports.
 The principle of comparative advantage states that each good should be
produced by the country that has the lower opportunity cost of producing that
good.
 To be sure, the issues involved in trade among nations are more
complex than this example suggests. When the United States
exports food and imports cars, the impact on an American farmer is
not the same as the impact on an American autoworker.
 Yet this example teaches an important lesson: Contrary to the
opinions sometimes voiced by politicians and pundits, international
trade is not like war, in which some countries win and others lose.
Trade allows all countries to achieve greater prosperity.
4. Conclusion
 You should now understand more fully the benefits of living in an interdependent
economy. When Americans buy tube socks from China, when residents of
Maine drink orange juice from Florida, and when a homeowner hires the kid next
door to mow her lawn, the same economic forces are at work. The principle of
comparative advantage shows that trade can make everyone better off.
 Having seen why interdependence is desirable, you might ask how it is possible.
How do free societies coordinate the diverse activities of all the people involved
in their economies? What ensures that goods and services will get from those
who should be producing them to those who should be consuming them? In a
world with only two people, such as Ruby the rancher and Frank the farmer, the
answer is simple: These two people can bargain and allocate resources
between themselves. In the real world with billions of people, the answer is less
obvious. We take up this issue in the next chapter, where we see that free
societies allocate resources through the market forces of supply and demand.
QuickQui
z the


a.
6. A nation will typically import those goods in which
nation has an absolute advantage.
b. the nation has a comparative advantage.
c. other nations have an absolute advantage.
d. other nations have a comparative advantage.

 7. Suppose that in the united States, producing an aircraft takes 10,000

hours of labor and producing a shirt takes 2 hours of labor. in china,
producing an aircraft takes 40,000 hours of labor and producing a
shirt takes 4 hours of labor. What will these nations trade?
a. China will export aircraft, and the United States will export shirts.
b. China will export shirts, and the United States will export aircraft.
c. Both nations will export shirts.
d. there are no gains from trade in this situation.
 8. Kayla can cook dinner in 30 minutes and wash the laundry in 20
minutes. her roommate takes twice as long to do each task. how should
the roommates allocate the work?
 Kayla should do more of the cooking based on her comparative
advantage.
 Kayla should do more of the washing based on her comparative
advantage.
 Kayla should do more of the washing based on her absolute advantage.
 there are no gains from trade in this situation.