Principles of Microeconomics
Ninth Canadian Edition by
Mankiw/Kneebone/McKenzie
Adapted for the Eighth Canadian Edition by
Marc Prud’Homme University of Ottawa
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 3
INTERDEPENDENCE
AND THE GAINS
FROM TRADE
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Interdependence and the Gains from Trade
• One of the ten principles of economics highlighted in Chapter 1
is that trade can make everyone better off.
• This principle explains why people trade with their neighbours and why
nations trade with other nations.
• What exactly do people gain when they trade with one another?
• Why do people choose to become interdependent?
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
A Parable for the Modern Economy (1 of 4)
• Imagine that in the world there are:
1. Two goods
• Meat and potatoes
2. Two people
• Cattle Rancher (Ruby) and Potato Farmer (Frank)
• Each would like to eat both meat and potatoes.
• Trade leads to greater variety.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
A Parable for the Modern Economy (2 of 4)
• Frank can raise cattle and produce meat, but he is not very good at it.
• Ruby can grow potatoes, but her land is not very well suited for it.
• Frank and Ruby can each benefit by specializing in what they do best and
then trade with the other.
• The gains from trade are less obvious, however, when one person is better
at producing every good.
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A Parable for the Modern Economy (3 of 4)
PRODUCTION POSSIBILITIES
• PRODUCTION POSSIBILITIES FRONTIER shows the various mixes of
output that an economy can produce.
• It illustrates one of the ten principles of economics in Chapter 1: People face
tradeoffs.
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
FIGURE 3.1: The Production Possibilities
Frontier (1 of 2)
(a) The Production Opportunities
Minutes Needed to Produce 1 kg
Meat
Potatoes
Frank
60 min/kg
15 min/kg
Ruby
20 min/kg
10 min/kg
Amount of Meat or Potatoes Produced in 8 Hours
Meat
Potatoes
Frank
8 kg
32 kg
Ruby
24 kg
48 kg
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
FIGURE 3.1: The Production Possibilities
Frontier (2 of 2)
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Production and Consumption
with and without Trade (1 of 3)
• Two countries: Canada and Japan
• Two goods: computers and wheat
• One resource: labour (measured in hours)
• We will look at how much of both goods each country produces and
consumes under two scenarios:
• If the country chooses to be self-sufficient
• If it trades with the other country
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Production and Consumption
with and without Trade (2 of 3)
To draw Canada’s PPF…
• Canada has 50 000 hours of labour available for production per month.
• Producing one computer requires 100 hours of labour.
• Producing one tonne of wheat requires 10 hours of labour.
Computers appear on the horizontal axis.
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Canada’s PPF
Canada has enough labour to produce
500 computers, or 5000 tonnes of wheat,
or any combination along the PPF.
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Canada without Trade
Suppose Canada uses half its labour
to produce each of the two goods.
Then it will produce and consume 250
computers and 2500 tonnes of wheat.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Production and Consumption
with and without Trade (3 of 3)
To draw Canada’s PPF…
• Canada has 30 000 hours of labour available for production per month.
• Producing one computer requires 125 hours of labour.
• Producing one tonne of wheat requires 25 hours of labour.
Computers appear on the horizontal axis.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Japan’s PPF
Japan has enough labour to produce 240
computers, or 1200 tonnes of wheat, or
any combination along the PPF.
3-14
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Japan without Trade
Suppose Japan uses half its labour to
produce each good.
Then it will produce and consume 120
computers and 600 tonnes of wheat.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Consumption with and without
Trade
• Without trade
• Canadian consumers get 250 computers and 2500 tonnes of wheat.
• Japanese consumers get 120 computers and 600 tonnes of wheat.
• We will compare consumption without trade to consumption with trade.
• First, we need to see how much of each good is produced and traded by the
two countries.
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Production under Trade
1. Suppose Canada produces 3400 tonnes of wheat. How many computers
would Canada be able to produce with its remaining labour?
• Draw the point representing this combination of computers and wheat on
Canada’s PPF.
2. Suppose Japan produces 240 computers. How many tonnes of wheat would
Japan be able to produce with its remaining labour?
• Draw this point on Japan’s PPF.
3-17
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Canada’s Production
with Trade
Producing 3400 tonnes of wheat
requires 34 000 labour hours.
The remaining 16 000 labour hours
are used to produce 160 computers.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Japan’s Production
with Trade
Producing 240 computers requires all
of Japan’s 30 000 labour hours.
So, Japan would produce 0 tonnes of
wheat.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Consumption under Trade
Suppose Canada exports 700 tonnes of wheat to Japan and imports 110
computers from Japan.
(Alternatively, Japan imports 700 tonnes of wheat and exports 110 computers.)
• How much of each good is consumed in Canada?
• Plot this combination on Canada’s PPF.
• How much of each good is consumed in Japan?
• Plot this combination on Japan’s PPF.
3-20
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Canada’s Consumption
with Trade
computers
wheat
Produced
+ imported
– exported
160
110
0
3400
0
700
= amount
consumed
270
2700
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Japan’s Consumption
with Trade
computers
wheat
Produced
+ imported
– exported
240
0
110
0
700
0
= amount
consumed
130
700
3-22
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Trade makes everyone
better off (1 of 2)
Canada
consumption
without trade
consumption
with trade
gains from
trade
computers
250
270
20
wheat
2500
2700
200
consumption
without trade
consumption
with trade
gains from
trade
computers
250
270
20
wheat
2500
2700
200
Japan
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Active Learning: Answers: Trade makes everyone
better off (2 of 2)
• Point F: 100 computers, 3000
tonnes of wheat
• Point F requires 40 000 hours of
labour. Possible but not efficient:
could get more of either good
without sacrificing any of the other
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
A Parable for the Modern Economy (4 of 4)
SPECIALIZATION AND TRADE
• After several years of eating combination B, Ruby gets an idea and goes to
talk to Frank.
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FIGURE 3.2: How Trade Expands the Set of
Consumption Opportunities (1 of 2)
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FIGURE 3.2: How Trade Expands the Set of
Consumption Opportunities (2 of 2)
(c) The Gains from Trade: A Summary
Meat from Frank Potatoes from
Frank
Meat from Ruby
Potatoes from
Ruby
4 kg
16 kg
12 kg
24 kg
Production
0 kg
32 kg
18 kg
12 kg
Trade
gets 5 kg
gives 15 kg
gives 5 kg
gets 15 kg
Consumption
5 kg
17 kg
13 kg
27 kg
+1 kg
+1 kg
+3 kg
Without Trade:
Production and
Consumption
With Trade:
Gains from Trade:
Increase in Consumption +1 kg
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Quick Quiz 1
1. Before Frank and Ruby engage in
trade, each
a. consumes at a point inside their
production possibilities frontier.
b. consumes at a point on their production
possibilities frontier.
c. consumes at a point outside their
production possibilities frontier.
d. consumes the same amounts of meat
and potatoes as the other.
2. After Frank and Ruby engage
in trade, each
a. consumes at a point inside their
production possibilities frontier.
b. consumes at a point on their
production possibilities frontier.
c. consumes at a point outside
their production possibilities
frontier.
d. consumes the same amounts of
meat and potatoes as the other.
3-28
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Comparative Advantage: The Driving Force of
Specialization (1 of 7)
• If Ruby is better at both raising cattle and growing potatoes, how can Frank
ever specialize in doing what he does best?
• Frank doesn’t seem to do anything best.
• To solve this puzzle, we need to look at the principle of comparative
advantage.
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Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Comparative Advantage: The Driving Force of
Specialization (2 of 7)
ABSOLUTE ADVANTAGE
• ABSOLUTE ADVANTAGE: the comparison among producers of a good
according to their productivity
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Comparative Advantage: The Driving Force of
Specialization (3 of 7)
OPPORTUNITY COST AND COMPARATIVE ADVANTAGE
• Rather than comparing inputs required, we can compare the opportunity
costs.
• OPPORTUNITY COST: whatever must be given up to obtain some item
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TABLE 3.1: The Opportunity Cost of Meat and
Potatoes
Frank the Farmer
Ruby the Rancher
Opportunity Cost for 1
kg of Meat
4 kg potatoes
Opportunity Cost for 1
kg of Potatoes
0.25 kg meat
2 kg potatoes
0.50 kg meat
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Comparative Advantage: The Driving Force of
Specialization (4 of 7)
COMPARATIVE ADVANTAGE AND TRADE
• COMPARATIVE ADVANTAGE: the comparison among producers of a good
according to their opportunity cost
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Comparative Advantage: The Driving Force of
Specialization (5 of 7)
COMPARATIVE ADVANTAGE AND TRADE
• The gains from specialization and trade are based not on absolute
advantage but rather on comparative advantage.
• When each person specializes in producing the good for which they have a
comparative advantage, total production in the economy rises.
• Each benefits from trade by obtaining a good at a price that is lower than
their opportunity cost of that good.
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Comparative Advantage: The Driving Force of
Specialization (6 of 7)
COMPARATIVE ADVANTAGE AND TRADE
• The moral of the story:
Trade can benefit everyone in society because it
allows people to specialize in activities in which
they have a comparative advantage.
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Comparative Advantage: The Driving Force of
Specialization (7 of 7)
THE PRICE OF TRADE
• What determines the price at which trade takes place?
• How are the gains from trade shared between the trading parties?
• For both parties to gain from trade, the price at which they trade must lie
between the two opportunity costs.
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
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Quick Quiz 2
3. In an hour, Mateo can wash 2 cars or 5. When Mateo and Sophia produce
mow 1 lawn, and Sophia can wash 3
efficiently and make a mutually
cars or mow 1 lawn. Who has the
beneficial trade based on
absolute advantage in car washing,
comparative advantage,
and who has the absolute advantage a. Mateo mows more and Sophia
in lawn mowing?
washes more.
a. Mateo in washing; Sophia in mowing b. Mateo washes more and Sophia
mows more.
b. Sophia in washing; Mateo in mowing
c. Mateo and Sophia both wash
c. Mateo in washing; neither in mowing
more.
d. Sophia in washing; neither in mowing d. Mateo and Sophia both mow more.
3-37
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Applications of Comparative Advantage (1 of 3)
SHOULD CONNOR MCDAVID SHOVEL HIS OWN SIDEWALK?
• McDavid can shovel his sidewalk
faster than anyone else. But
should he?
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Applications of Comparative Advantage (2 of 3)
SHOULD CANADA TRADE WITH OTHER COUNTRIES?
• Just as individuals can benefit from specialization and trade with one
another, so can populations of people in different countries.
• IMPORTS: goods and services produced abroad and sold domestically.
• EXPORTS: goods and services produced domestically and sold abroad.
• The principle of comparative advantage states that each good should be
produced by the country that has the smaller opportunity cost of producing
that good.
3-39
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Applications of Comparative Advantage (3 of 3)
SHOULD CANADA TRADE WITH OTHER COUNTRIES?
• The opportunity cost of a car is 2 tonnes of food in Canada but only 1 tonne
of food in Japan, Japan has a comparative advantage in producing cars.
• Japan should produce more cars than it wants for its own use and export some of
them to Canada.
• The opportunity cost of a tonne of food is 1 car in Japan but only 1/2 car in
Canada; Canada has a comparative advantage in producing food.
• Canada should produce more food than it wants to consume and export some to
Japan.
• Through specialization and trade, both countries can have more food and
more cars.
3-40
Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
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Quick Quiz 3
6. A nation will typically
import those goods in
which
a. the nation has an
absolute advantage.
b. the nation has a
comparative advantage.
c. other nations have an
absolute advantage.
d. other nations have a
comparative advantage.
8. Kayla can cook dinner in 30 minutes and wash
the laundry in 20 minutes. Her roommate
takes twice as long to do each task. How
should the roommates allocate the work?
a. Kayla should do more of the cooking based on
her comparative advantage.
b. Kayla should do more of the washing based on
her comparative advantage.
c. Kayla should do more of the washing based on
her absolute advantage.
d. There are no gains from trade in this situation.
3-41
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Classroom Activity
A Short Trip with Many Contributors
Answer the following questions:
1. Think of a recent trip you have taken. The distance travelled is unimportant;
just choose a specific trip. Where did this trip start and finish?
2. Who produced the goods and services that made your trip possible? (List as
many types of workers as possible.)
3. How were the different elements of your trip financed (e.g., the vehicle, the
road network, or the airport)?
3-42
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THE END
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Mankiw/Kneebone/McKenzie, Principles of Microeconomics, 9th Canadian Edition. © 2024 Cengage Learning Ltd. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.