Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Interdependence and Trade Economics studies how society produces and distributes goods and services so that wants and needs are satisfied.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition How Do We Satisfy Our Wants and Needs? À We can be economically Self-Sufficient. Á We can specialize and trade with others leading to Economic Interdependence.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Interdependence & Trade u A general observation... – Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity. u This gives rise to two questions... – Why is interdependence the norm? – What determines production & trade?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Interdependence & Trade u Why is interdependence the norm? – Interdependence occurs because people are better off when they specialize and trade with others. u What determines the pattern of production & trade? – Patterns of production and trade are based upon differences in opportunity costs.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Interdependence and Trade: “A Parable for the Modern Economy” Imagine... … only two goods (potatoes and meat) … only two people (potato farmer and a cattle rancher) What should each produce? Why should they trade?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Productivity Table u Note that based on the Productivity Table above the Rancher is more productive in producing both of the products. u Yet, we will see that both the Rancher and the Farmer can gain from trade...

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Product Possibility Frontiers Based on the Productivity Table above we can construct Productivity Possibility Frontiers assuming an 8 hour day as follows: Meat in Kg Farmer Potatoes in Kg 8 8 Meat in Kg Potatoes in Kg Rancher PPF

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition A World of Self-Sufficiency Assuming self sufficiency (no trade) the Farmer produces and consumes combination A, while the Rancher is at combination B: Meat in Kg Farmer Potatoes in Kg 8 8 Meat in Kg Potatoes in Kg Rancher B 32 8 A 4 4

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Specialization and Trade u If the farmer and the rancher were to specialize in producing the product that they were best suited to produce, and then trade with each other, they would be better off. – Farmer should produce potatoes. – Rancher should produce meat. – Farmer and Rancher should trade.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Specialization and Trade Suppose the Farmer specializes in Potatoes and the Rancher specializes in Meat. If the Farmer trades 5 Kg Potatoes for 10 Kg Meat: Meat in Kg Farmer Potatoes in Kg 8 8 Meat in Kg Potatoes in Kg Rancher B 48 4 A 6 2 A* trade B* trade

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition The Principle of Comparative Advantage u What determines who should produce what? And how much should be traded for each product? Differences in Costs of Production u Who can produce products (e.g. potato, meat) at a lower cost? u There are two ways to measure...

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition The Principle of Comparative Advantage u Measuring differences in costs of production: – Hours required to produce a standardized unit of output. v One pound of potatoes – Opportunity Cost - amount of one item sacrificed to obtain another.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Absolute Advantage u Describes the productivity of one person, firm, or nation to that of another. - The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Productivity Table u Who has the Absolute Advantage in each product? u Rancher, in both products. u Yet, we have seen that both the Rancher and the Farmer can gain from trade?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Comparative Advantage u Compares producers of a good according to their opportunity cost. - The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition The Principle of Comparative Advantage u Comparative advantage, which refers to differences in opportunity costs, is the basis for specialized production and trade. u Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Opportunity Cost Table u Based on the Productivity Table (earlier slide) you can use simple math to calculate the opportunity cost of 1 unit of each good. u The Rancher has the Comparative Advantage in producing Meat (lower opportunity cost). u The Farmer has the Comparative Advantage in producing Potatoes (lower opportunity cost).

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Applications of Comparative Advantage u Should Canada trade with Other Countries (e.g. Japan)? – Opportunity Costs – Imports – Exports

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Trade: Canada and Japan Cars Food CanadaJapan 4 2 Food 2 2

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Opportunity Cost: Sacrifice of Food Production for Car Production Computing Opportunity Cost Slope of PPF: (0-4) ÷ (2-0) = 2 Units of food given up to get 1 Unit of a car. Cars Canada 4 2 Food

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Opportunity Cost: Sacrifice of Food Production for Car Production Computing Opportunity Cost Slope of PPF: (0-4) ÷ (2-0) = ? Units of food given up to get 1 Unit of a car Cars Canada 4 2 Food 1 ?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Opportunity Cost: Sacrifice of Food Production for Car Production Computing Opportunity Cost Slope of PPF: (0-4) ÷ (2-0) = 2 Units of food given up to get 1 Unit of a car Cars Canada 4 2 Food 2 1

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Opportunity Cost: Sacrifice of Food Production for Car Production Computing Opportunity Cost Slope of PPF: ( 2 ) ÷ (2 ) = 1 Unit of food given up to get 1 Unit of a car Cars Japan 2 2 Food

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Trade: Canada and Japan Cars Food CanadaJapan 4 2 Food

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Cars Food CanadaJapan 4 2 Food Who should produce Cars?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Cars Food CanadaJapan 4 2 Food Who should produce Food?

Principles of Microeconomics & Principles of Macroeconomics: Ch. 3 First Canadian Edition Interdependence: Canada & Japan Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. Founded upon the... Principle of Comparative Advantage