chapt 3

• Interdependence


  People rely on many others, most of whom they have never met, to provide the goods and services they enjoy
• People provide goods and services to others not out of generosity, but because they get something in return
• Production possibilities frontier


  • Illustrates the trade-offs an economy faces in producing different goods
  • Shows the various mixes of output an economy can produce
• Constant rate of trade-off


  The rate at which Frank can switch between producing meat and potatoes is constant, regardless of how much he is already producing
• Specialization and trade


  1. Frank stops producing meat and devotes all time to potatoes

  2. Ruby spends more time raising cattle and less time growing potatoes

  3. Each person consumes more of both goods after trade
• Specialization and trade


  Allow each person to consume more of both goods without working more hours
• If one person is better at producing every good, there may still be gains from trade
• Comparative advantage, not absolute advantage, is the driving force of specialization and trade
• 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
• It is impossible for one person to have a comparative advantage in both goods
• Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage
• For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs
• Adam Smith and David Ricardo were influential economists who developed the principle of comparative advantage
• The principle of comparative advantage explains interdependence and the gains from trade
• Interdependence is prevalent in the modern world, so the principle of comparative advantage has many applications
• The conclusions of Adam Smith and David Ricardo on the gains from trade have held up well over time
• Economists often disagree on questions of policy, but they are united in their support of free trade
• The central argument for free trade has not changed much in the past two centuries
• Even though the field of economics has broadened its scope and refined its theories since the time of Smith and Ricardo, economists' opposition to trade restrictions is still based largely on the principle of comparative advantage
• Comparative advantage


  The principle that explains interdependence and the gains from trade
• Interdependence is so prevalent in the modern world, the principle of comparative advantage has many applications
• Opportunity cost


  The value of the best alternative forgone
• Comparative advantage


  A situation that arises when a country can produce a good at a lower opportunity cost than another country
• The gains from trade in this example are tremendous. Serena should make the commercial and hire Forrest to mow the lawn, as long as she pays him more than $50 and less than $30,000
• Imports


  Goods produced abroad and sold domestically
• Exports


  Goods produced domestically and sold abroad
• The United States has a comparative advantage in producing food, while Japan has a comparative advantage in producing cars. Through specialization and trade, both countries can have more food and more cars.
• International trade can make some individuals worse off, even as it makes the country as a whole better off. Yet, 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.
• 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
• Principle of comparative advantage


  Trade can make everyone better off
• 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
• Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services
• Absolute advantage


  The person who can produce the good with the smaller quantity of inputs
• Comparative advantage


  The person who has the smaller opportunity cost of producing the good
• 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
• Imports


  Goods and services purchased from other countries