Gains from Trade SimulatorChapter 3: Interdependence and the Gains from Trade

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U.S.
Japan

Step 1: Production

Each country picks a point on its own PPF. The rest of its labor goes to the other good.

Step 2: Trade

Step 3: Consumption and gains from trade

Absolute vs comparative advantage

Practice quiz: questions from Chapter 3

Each round gives you 10 random questions. After you answer, use Show on graph to load the scenario in the simulator.

Chapter 3 in brief

Why do people and nations choose to be interdependent, and how can trade make everyone better off? The answer is comparative advantage.

The example: U.S. and Japan, computers and wheat
Labor hoursHours per computerHours per ton of wheatMax computersMax wheat
U.S.50,000100105005,000
Japan30,000125252401,200
Without trade, each country uses half its labor on each good and consumes what it produces: U.S. 250 computers and 2,500 tons; Japan 120 computers and 600 tons.
Production and consumption with trade
The U.S. produces 3,400 tons of wheat (34,000 hours) and 160 computers (16,000 hours). Japan produces 240 computers and no wheat. The U.S. exports 700 tons of wheat and imports 110 computers. Consumption = production + imports − exports.
U.S.Japan
computerswheatcomputerswheat
produced1603,4002400
+ imported11000700
− exported07001100
= consumed2702,700130700
without trade2502,500120600
gains from trade+20+200+10+100
Both consumption points lie outside the country's PPF: trade untethers consumption from production, much like technological progress.
Exports and imports
Imports: goods produced abroad and sold domestically. Exports: goods produced domestically and sold abroad. A German tourist's $200 spent on a Las Vegas show counts as a U.S. export: produced here, bought by a foreigner, wherever it is consumed.
Absolute advantage
The ability to produce a good using fewer inputs than another producer. The U.S. has the absolute advantage in wheat (10 hours vs 25) AND in computers (100 hours vs 125). So why does Japan specialize in computers, and why do both gain?
Comparative advantage
The ability to produce a good at a lower opportunity cost than another producer.
  • Opportunity cost of a computer in the U.S.: 100 hours could grow 10 tons of wheat, so 10 tons.
  • Opportunity cost of a computer in Japan: 125 hours could grow 5 tons, so 5 tons.
  • Japan has the comparative advantage in computers; the U.S. (1/10 computer per ton vs 1/5) in wheat.
Principle of comparative advantage: each good should be produced by the producer with the smaller opportunity cost. Gains from trade come from differences in opportunity costs, not from absolute advantage.
Key lessons
  • Absolute advantage is not necessary for comparative advantage.
  • One producer can have an absolute advantage in both goods but never a comparative advantage in both: the opportunity cost of one good is the inverse of the other.
  • With different opportunity costs, each producer has a comparative advantage in one good.
  • The price of trade must lie between the two opportunity costs (between 5 and 10 tons per computer here; the chapter's 700 tons for 110 computers is about 6.4).
  • Trade makes the country as a whole better off, though some workers in import-competing industries can be worse off.
Active Learning 4: Argentina and Brazil
Each has 10,000 hours. Argentina: 2 hours per lb of coffee, 4 hours per bottle of wine. Brazil: 1 hour per lb of coffee, 5 hours per bottle of wine.
  • Brazil has the absolute advantage in coffee (1 hour vs 2).
  • Opportunity cost of wine: Argentina 2 lb of coffee; Brazil 5 lb. Argentina has the comparative advantage in wine.