Chapter 3: Interdependence and the Gains from Trade

Vocabulary flashcards covering key terms and concepts from the lecture notes on interdependence, absolute and comparative advantage, and the gains from trade.

Interdependence

A situation in which individuals or countries rely on others for goods and services; trade increases the quantity and variety of goods available to everyone.

Absolute advantage

The ability to produce a good with fewer inputs or more output with the same inputs; the producer with the smaller quantity of inputs has absolute advantage.

Comparative advantage

The ability to produce a good at a lower opportunity cost than others.

Opportunity cost

What you must give up to obtain something; the next-best alternative forgone.

Gains from trade

Trade allows specialization based on comparative advantage, increasing total output and making both parties better off.

Specialization

Concentrating production on goods for which one has a comparative advantage to improve overall output.

Production Possibilities Frontier (PPF)

A curve showing the maximum feasible combinations of two goods with given resources; illustrates tradeoffs and opportunity costs; in the notes, sometimes drawn linearly for simplicity.

Meat and potatoes parable

A simple two-good, two-person model using a farmer and a rancher to illustrate gains from trade due to comparative advantage.

Rancher absolute advantage

In the meat and potatoes example, the rancher can produce both potatoes and meat with fewer inputs, giving him an absolute advantage.

Farmer comparative advantage in potatoes

The farmer has a lower opportunity cost in producing potatoes than the rancher.

Rancher comparative advantage in meat

The rancher has a lower opportunity cost in producing meat than the farmer.

Free trade

Trade without tariffs or barriers; economists generally support it as beneficial due to comparative advantage.

Imports

Goods produced abroad and sold domestically.

Exports

Goods produced domestically and sold abroad.

Tariff

A tax on imported goods intended to reduce imports and protect domestic producers.

Adam Smith

Author of The Wealth of Nations (1776); argued for specialization and free trade as a benefit of economic interdependence.

David Ricardo

Author of Principles of Political Economy and Taxation (1817); developed the theory of comparative advantage and argued against restrictions on free trade.

Terms of trade in the meat-potatoes example

A negotiated exchange like 3 pounds of meat for 1 pound of potatoes; this implies meat costs 1/3 of a potato and lies between the two parties’ opportunity costs, making trade beneficial.