1. Chapter 4 Essential Question: How does trade make people better off?
Gains from Trade
Chapter 4
Essential Question:
How does trade make people better off?

2. Specialization
Adam Smith said specialization is where we do what we’re good at.
This is division of labor where each person does his own job.
This encourages trade
We swap goods/services (blacksmith swaps for eggs)
Voluntary exchange – both sides agree to give up & get something
Barter – a good/service for a good/service
Money – makes trade easier (blacksmith buys loaf of bread)
Trade makes economic interdependence
We depend on others for things
Trade barriers – should we be allowed to trade with others freely or with rules? (Adam Smith—free; Donald Trump—with rules)

3. Advantages (absolute & comparative)
Stranded on an island…
Selkirk
Pirate Jack
Turnips or Clams?
Absolute advantage – the person/country that can produce more (of either item on a PPF)
Abs. adv. is the line farthest out from zero (red = Pirate Jack)

4. Cont. Remember, inside the PPF is possible, but inefficient.
Outside the PPF is impossible.

5. Advantages (cont.)
Comparative advantage – is measured in opportunity cost…
…opp. cost is what’s given up
Turnips or clams? (chart p64 for Selkirk and Pirate Jack)
Column 1 – dig 1 turnip – Selkirk gives up 1 clam; P.J. gives up ½ clam.
Who gives up less digging turnips? So…
…P.J. has comparative advantage in digging turnips.
Col. 2 – find 1 clam – Selkirk gives up 1 turnip; P.J. gives up 2 turnips.
Who gives up less finding clams? So…
…Selkirk has comparative advantage in finding clams.

6. Cont. Shortcut to find comparative advantage…
…look at the slope of the line.
If NOT parallel, one country will have a comparative advantage with one product, the other country with the other product.
The “flatter” line “points” to the comp adv.

7. Advantages (cont.) Remember, outside the PPF is impossible. But…
…if they trade, they CAN get outside the PPF.
Bottom line: do what you’re good at (do what you have comparative advantage at), then trade.