Interdependence and the Gains from Trade (CH03)

3-1 A Parable for the Modern Economy

3-1a Production Possibilities

3-1b Specialization and Trade

3-2 Comparative Advantage: The Driving Force of Specialization

3-2a Absolute Advantage

3-2b Opportunity Cost and Comparative Advantage

3-2c Comparative Advantage and Trade

3-2d The Price of the Trade

3-3 Applications of Comparative Advantage

3-3a Should Tom Brady Mow His Own Lawn?

3-3b Should the United States Trade with Other Countries?

Summary:

• Each person consumes goods and services produced by many other people both in the United States and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.
• There are two ways to compare the ability of two people to produce a good. The person who can produce the good with the smaller quantity of inputs is said to have an absolute advantage in producing the good. The person who has the smaller opportunity cost of producing the good is said to have a comparative advantage. The gains from trade are based on comparative advantage, not absolute advantage.
• Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage.
• The principle of comparative advantage applies to countries as well as to people. Economists use the principle of comparative advantage to advocate free trade among countries.

Key Concepts:

Absolute advantage: The ability to produce a good using fewer inputs than another producer.

Opportunity Cost: Whatever must be given up to obtain some item.

Comparative advantage: The ability to produce a good at a lower opportunity cost than another producer.

Imports: Goods produced abroad and sold domestically.

Exports: Goods produced domestically and sold abroad.