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Unformatted text preview: Chapter 3 Interdependence and the Gains from Trade WHATS NEW IN THE THIRD EDITION: The discussion of gains from trade and comparative advantage has been rewritten for improved clarity. LEARNING OBJECTIVES: By the end of this chapter, students should understand: how everyone can benefit when people trade with one another. the meaning of absolute advantage and comparative advantage. how comparative advantage explains the gains from trade. how to apply the theory of comparative advantage to everyday life and national policy. CONTEXT AND PURPOSE: Chapter 3 is the third chapter in the three chapter section that serves as the introduction of the text. The first chapter introduced ten fundamental principles of economics. The second chapter developed how economists approach problems. This chapter shows how people and countries gain from trade (which is one of the ten principles discussed in Chapter 1). The purpose of Chapter 3 is to demonstrate how everyone can gain from trade. Trade allows people to specialize in the production of goods for which they have a comparative advantage and then trade for goods other people produce. Because of specialization, total output rises and through trade we are all able to share in the bounty. This is as true for countries as it is for individuals. Since everyone can gain from trade, restrictions on trade tend to reduce welfare. 35 3 INTERDEPENDENCE AND THE GAINS FROM TRADE 36 Chapter 3/Interdependence and the Gains from Trade KEY POINTS: 1. Each person consumes goods and services produced by many other people both in our country and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. 2. There are two ways to compare the ability of two people in producing a good. The person who can produce the good with a 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. 3. Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage. 4. The principle of comparative advantage applies to countries as well as people. Economists use the principle of comparative advantage to advocate free trade among countries....
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This note was uploaded on 11/16/2009 for the course ECO 1001 taught by Professor Dr.sum during the Fall '08 term at Al Ahliyya Amman University.
- Fall '08