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Unformatted text preview: 3 Interdependence and the Gains from Trade Goals In this chapter you will Consider how everyone can benefit when people trade with one another Learn the meaning of absolute advantage and comparative advantage See how comparative advantage explains the gains from trade Apply the theory of comparative advantage to everyday life and national policy Outcomes After accomplishing these goals, you should be able to Show how total production rises when individuals specialize in the production of goods for which they have a comparative advantage Explain why all people have a comparative advantage even if they have no absolute advantage Demonstrate the link between comparative advantage and opportunity cost Explain why people who are good at everything still tend to specialize Chapter Overview 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. Chapter Review Introduction Each of us consumes products every day that were produced in a number of different countries. Complex products contain components that were produced in many different countries so these products have no single country of origin. Those who produce are neither generous nor ordered by government to produce. People produce because they wish to trade and get something in return. Hence, trade makes us interdependent. A Parable for the Modern Economy Imagine a simple economy. There are two peoplea cattle rancher and a potato farmer. There are two goodsmeat and potatoes. If each can produce only one product (the rancher can produce only meat and the farmer potatoes), they will trade just to increase the variety of products they consume. Each benefits because of increased variety. If each can produce both goods, but each is more efficient than the other at producing one good, then each will specialize in what he or she does best (again the rancher produces meat and the farmer produces potatoes), total output will rise, and they will trade. Trade allows each to benefit because trade allows for specialization, and specialization increases the total production available to share....
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