Chapter 3: Interdependence & Gains from Trade
Absolute Advantage: the comparison among producers of a good according to their productivity. 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: the comparison among producers of a good according to their opportunity
Opportunity Cost: whatever must be given up to obtain some item.
Note: It is possible for one person to have an absolute advantage in both goods, but it is impossible for
one person to have comparative advantage in both goods because the opportunity cost of one good is
the inverse of the opportunity cost of the other; if a person’s opportunity cost of one good is relatively
high, his opportunity cost of the other good must be relatively low.
-The gains from specialization and trade are not based on absolute advantage but on comparative
advantage. For both parties to gain from trade, the price at which they trade must lie between the two
50,000 hours of labor available for production per month.
1 Computer= 100 hours of labor
1 Ton of Wheat= 10 hours of labor
*Calculation: Canada has 50,000 labor hours. It takes
100 hours to produce a computer.
If Canada uses all of its labor hours to produce
computers, then it will produce 50,000/100 = 500
computers therefore horizontal axis is (500 computers,
It takes 10 hours to produce a ton of wheat. If Canada
uses all of its labor to produce wheat, then it will
produce 50,000/10 = 5000 tons of wheat therefore
vertical axis is (0 computers, 5000 tons of wheat)
Canada without trade: if it uses half of its labor to
produce each of the two goods = 250 computers and
2500 tons of wheat. Japan:
-300,000 hours of labor available for production per month
1 Computer = 125 hours of labor
1 Ton of Wheat= 25 hours of labor
Horizontal intercept (30,000/135) = 240 computers.
Vertical intercept (30,000/25) = 1200 tons of wheat
Japan without Trade: if it uses half of its labor then it will
produce and consumer 120 computers and 600 tons of
Without Trade from Both Companies:
Canada: consumers get 250 computers and 2500 tons of wheat
Japan: consumers get 120 computers and 600 tons of wheat
Question: Suppose Canada produces 3400 tons of
wheat. How many computers would Canada be able to
produce with its remaining labor?
Answer: Producing 3400 tons of wheat requires 34000
labor hours therefore the remaining 16,000 hours are
used to produce 160 computers
Question: Suppose Japan produces 240 computers. How
many tons of