Interdependence and the Gains from Trade zAn Example of Benefiting from Trade zAbsolute Advantage &...

Interdependence and the Gains from Trade

An Example of Benefiting from TradeAbsolute Advantage & Comparative

Advantage

Absolute & Comparative Advantage

Absolute advantage tells us who can produce something with fewer resources or produce more of something with the same resources (who is more productive)

Comparative advantage tells us who can produce something at a lower opportunity cost (who gives up the least)

Can a country that has an absolute advantage, benefit from trade?

Benefiting from Trade

Suppose Mu and Les produce food and clothing

In Mu one worker can produce 6 units of food or 3 units of clothing

In Les, one worker can produce 1 unit of food or 2 units of clothing

Mu has the absolute advantage in both goods


Would these countries be better off with trade; could they consume more?


If there are 10 million workers in Mu and 20 million in Les we get the following PPFs


MU LESFood Clothing Food Clothing 60 0 20 0 50 5 15 10 40 10 10 20 30 15 5 30 20 20 0 40 10 25 0 30


Opportunity cost of 1 food (What they give up for a unit of food) Mu = 1/2 clothing (give up 1/2 clothing) Les = 2 clothing (give up 2 clothing)

Opportunity cost of 1 clothing (What they give up for a unit of clothing) Mu = 2 food (give up 2 food) Les = 1/2 food (give up 1/2 food)


Mu has a comparative advantage in the production of food (costs them less in terms of clothing)

Les has a comparative advantage in the production of clothing (costs them less in terms of food)


Suppose they decide to trade with each Suppose 1 unit of food trades for 1 unit of

food If Mu gives up 10 units of food, it gets

10 units of cloth If Les gives up 10 units of cloth, it gets

10 units of foodCountries have same PPFs, but different

consumption opportunities


With trade, Mu produces 60 units of food They can trade away 10 units of food

and receive 10 units of clothing This will give them the consumption

opportunity of 50 units of food and 10 units of clothing

Without trade their consumption opportunity was 50 units of food and 5 units of clothing


With trade, Les produces 40 units of clothing

They can trade away 10 units of clothing and receive 10 units of food

This will give them the consumption opportunity of 30 units of clothing and 10 units of food

Without trade their consumption opportunity was 5 units of food and 30 units of clothing


Both countries are made better off by trade based on comparative advantage

They are able to consume more goods and services with trade, than if they were self-sufficient


When Mu and Les join forces to trade, we get MULES

Obviously, MULES are an awesome force and trade is a good thing


Specialization and trade should be based on comparative advantage - specialize in what you produce at the lowest opportunity cost and trade for other stuff

Specialization and trade based on comparative advantage will make both parties better off


This is true not just for nations, but also for states, cities, and individuals

All can be made better off by trade based on comparative advantage

Interdependence and the Gains from Trade zAn Example of Benefiting from Trade zAbsolute Advantage &...

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