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Principles of Economics, Chapter 3

by: Devon Black

Principles of Economics, Chapter 3 Econ 10A

Marketplace > Harvard University > Economics > Econ 10A > Principles of Economics Chapter 3
Devon Black
Harvard University

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These notes cover advantages in trade. These are the last notes for Part 1. The next notes will start Part 2: How Markets Work.
Principles of Economics
N. Gregory Mankiw
Class Notes
trade, International Trade, Microeconomics, Macroeconomics, Economics
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This 2 page Class Notes was uploaded by Devon Black on Saturday September 3, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 4 views. For similar materials see Principles of Economics in Economics at Harvard University.

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Date Created: 09/03/16
Principles of Economics, 7 thed. Chapter 3: Interdependence and the Gains from Trade I) A Parable for the Modern Economy A) Dealing with a potato farmer named Frank and a meat farmer named Rose who both have greater variety of meals when they trade with each other 1) Benefits of trade more ambiguous when someone is better at making every type of good B) Production Possibilities 1) If there is no trade, the production possibilities frontier equals the consumption possibilities frontier 2) In this scenario, the production possibilities frontier graph is straight, not bowed, meaning that Frank’s technology allows him to switch between making potatoes and meat at a constant rate C) Specialization and Trade 1) By allowing people to specialize, they are producing more of what they produce best without working more hours II) Comparative Advantage: The Driving Force of Specialization A) Absolute Advantage 1) Different kinds of inputs: time, money B) Opportunity Cost and Comparative Advantage 1) While possible for a person to have an absolute advantage in both goods they produce, it’s impossible for them to have a comparative advantage in both goods they produce (a) Opportunity cost of one good is the inverse of the opportunity cost of the other (b) If opportunity cost is high in one good, it’s low in the other  can’t have comparative advantage in both goods C) Comparative Advantage and Trade 1) Gains from specialization and trade are based on comparative advantage, not absolute advantage (a) Both sides benefit by getting a good at a cost that is lower than their opportunity cost for that item 2) Specialization  rise in total production D) The Price of the Trade 1) For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs III) Applications of Comparative Advantage A) Should Tom Brady Mow His Own Lawn? 1) Suppose Tom Brady mows his lawn faster than anyone else and can do it in 2 hours. In that time frame, he can also film a commercial and get paid $20k. Obviously, even though he’s super awesome at mowing lawns and not much else, he should not mow his own lawn 2) Forrest Gump can mow the lawn in 4 hours or work at his job and earn $40 3) Tommy has an absolute advantage in both situations, but because his opportunity cost for mowing the lawn is $20k and Forrest’s in $40, he has the comparative advantage in only one and really, according to N. Greg Mankiw, he has the advantage in the only situation that matters B) Should the United States Trade with Other Countries 1) Countries specialize in things 2) US and Japan both make food and cars (a) Equally good at making cars (untrue) (b) America has better land and therefore produces twice as much food (c) Japan’s opportunity cost for one car is one ton of food whereas for America it’s 2 tons of food (1) Therefore Japan makes the cars (d) Japan’s opportunity cost for one ton of food is one car whereas for America it’s half a car (1) Therefore America makes the food 3) Trade is not like war, with a winner and a loser (a) Trade allows countries to get more of pretty much everything Vocabulary: 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 Imports: goods produced abroad and sold domestically Exports: goods produced domestically and sold abroad


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