GAINS FROM TRADE
ETP Economics 101
Lecturer: Jack Wu
AUTARKY (自給自足)OR TRADE?

How do we satisfy our wants and needs in a
global economy?
We can be economically self-sufficient (Autarky).
 We can specialize and trade
with others, leading to
economic interdependence.

CASE 1: THE SIMPLEST ECONOMY
only two goods: potatoes and meat
 only two people: a potato farmer and a cattle
rancher
 Each only works 8 hours/day

What should each produce?
 Why should they trade?

CASE 1 (CONTINUED)
Minutes needed to make 1 ounce of
___________________________________
Meat
Potatoes
___________________________________
Farmer
60min/oz
15min/oz
Rancher
20min/oz
10min/oz

CASE 1 (CONTINUED)
Amounts produced in 8 hours
___________________________________
Meat
Potatoes
___________________________________
Farmer
8 oz
32 oz
Rancher
24 oz
48 oz

THE FARMER’S PRODUCTION POSSIBILITIES FRONTIER
(a) The Farmer ’s Production Possibilities Frontier
Meat (ounces)
8
0
32
Potatoes (ounces)
THE RANCHER’S PRODUCTION POSSIBILITIES FRONTIER
(b) The Rancher ’s Production Possibilities Frontier
Meat (ounces)
24
0
48
Potatoes (ounces)
OPPORTUNITY COST

Definition
Whatever must be given up to obtain some item
 Measures the trade-off between the two goods that
each producer faces

CASE 1(CONTINUED): OPPORTUNITY COSTS
1oz of meat
1oz of potatoes
Farmer
4 oz of potatoes
¼ oz of meat
Rancher
2 oz of potatoes
½ oz of meat
ABSOLUTE ADVANTAGE

The comparison among producers of a good
according to their productivity—absolute
advantage
Describes the productivity of one person, firm, or
nation compared 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.

COMPARATIVE ADVANTAGE

Compares producers of a good according to their
opportunity cost.


Whatever must be given up to obtain some item
The producer who has the smaller opportunity
cost of producing a good is said to have a
comparative advantage in producing that good.
QUICK QUIZ 1 FROM CASE 1
Who has the absolute advantage?
 The farmer or the rancher?

Who has the comparative advantage?
 The farmer or the rancher?

SPECIALIZATION AND TRADE

Comparative advantage and differences in
opportunity costs are the basis for specialized
production and trade.
QUICK QUIZ 2 FROM CASE 1
What should farmer produce (or specialize in)?
 What should rancher produce (or specialize in)?

BENEFITS OF TRADE
Whenever potential trading parties have
differences in opportunity costs, they can each
benefit from trade.
 Benefits of Trade


Trade can benefit everyone in a society because it
allows people to specialize in activities in which they
have a comparative advantage.
SELF-SUFFICIENCY (AUTARKY)

By ignoring each other:
Each consumes what they each produce.
 The production possibilities frontier is also the
consumption possibilities frontier.
 Without trade, economic gains are diminished.

SELF-SUFFICIENCY (AUTARKY) IN CASE 1

Assume: Farmer spends 4 hours on meat and 4
hours on potatoes. Rancher spends 4 hours on
meat and 4 hours on potatoes.
CASE 1 (CONTINUED): WITHOUT TRADE


Production: Farmer produces 4 oz of meat and 16
oz of potatoes. Rancher produces 12 oz of meat
and 24 oz of potatoes.
Consumption: Farmer consumes 4 oz of meat and
16 oz of potatoes. Rancher consumes 12 oz of
meat and 24 oz of potatoes.
THE FARMER’S PRODUCTION AND CONSUMPTION WITHOUT
TRADE
(a) The Farmer’s Production and Consumption
Meat (ounces)
Farmer's
production and
consumption
without trade
8
4
A
0
32
Potatoes (ounces)
16
Copyright©2003 Southwestern/Thomson Learning
THE RANCHER’S PRODUCTION AND CONSUMPTION WITHOUT
TRADE
(b) The Rancher’s Production and Consumption
Meat (ounces)
24
B
12
0
24
Rancher's
production and
consumption
without trade
48
Potatoes (ounces)
Copyright © 2004 South-Western
ONE PROPOSAL FOR SPECIALIZATION
Farmer devotes all his time to growing potatoes.
 Rancher spends 6 hours a day raising cattle and
2 hours growing potatoes.

PRODUCTION UNDER THIS PROPOSAL
Farmer’s production with Specialization: 0 oz of
meat and 32 oz of potatoes
 Rancher’s production with Specialization: 18 oz of
meat and 12 oz of potatoes.

PROPOSAL FOR TRADE

The price of trade


Must lie between the two opportunity costs
Trade deal: Farmer gives rancher 15 oz of
potatoes, and rancher gives farmer 5 oz of meat
in return.
Note: Trade Price of Meat: 2~4 oz of potatoes
 Note: Trade Price of Potatoes: 1/4 oz ~1/2 oz of
meat

CONSUMPTION WITH TRADE
Farmer’s consumption with trade: 5 oz of meat
and 17 oz of potatoes
 Rancher’s consumption with trade: 13 oz of meat
and 27 oz of potatoes.

HOW TRADE EXPANDS THE FARMER’S SET OF CONSUMPTION
OPPORTUNITIES
(a) The Farmer’s Production and Consumption
Meat (ounces)
8
Farmer's
consumption
with trade
A*
5
4
Farmer's
production and
consumption
without trade
A
Farmer's
production
with trade
0
32
16
17
Potatoes (ounces)
HOW TRADE EXPANDS THE RANCHER’S SET OF
CONSUMPTION OPPORTUNITIES
(b) The Rancher’s Production and Consumption
Meat (ounces)
Rancher's
production
with trade
24
Rancher's
consumption
with trade
18
13
B*
B
12
0
12
24 27
Rancher's
production and
consumption
without trade
48
Potatoes (ounces)
INTERNATIONAL TRADE

Each country has many citizens with different
interests. International trade can make some
individuals worse off, even as it makes the
country as a whole better off.

Imports—goods produced abroad and sold
domestically

Exports—goods produced domestically and sold
abroad
QUICK QUIZ 3

Martha and Stewart each spend 8 hours a day
wallpapering and painting:
Martha
Stewart
Hours needed to Do 1 Room
Paint
Wallpaper
2 hours/room 8 hours/room
4 hours/room 10 hours/room
QUESTIONS

Draw production possibility frontiers for both Martha and
Stewart. (Painting on horizontal axis and Wallpaper on vertical
axis)

Find out the opportunity costs.

Who has an absolute advantage in painting? Wallpapering? Why?




Who has a comparative advantage in painting? Wallpapering?
Why?
If both trade works with each other, who will trade away painting
in exchange for wallpapering?
What is the highest price at which painting can be traded that
would make both better off? What is the lowest price?
Starting from a position without trade, give an example in which
trade makes each of them better off.