Chapter 3- Interdependence and the gain from trade

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Rowan University *

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04.102

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Anthropology

Date

Oct 30, 2023

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docx

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Uploaded by 14kaitlyn2002

Chapter 3: Interdependence and the gain from trade A parable for the modern economy • Only two goods – Meat – Potatoes • Only two people – A cattle rancher named Ruby – A potato farmer named Frank – Both would like to eat both meat and potatoes • If Ruby produces only meat and Frank produces only potatoes – Both gain from trade • If both Ruby and Frank produce both meat and potatoes – Both gain from specialization and trade • Production possibilities frontier – Various mixes of output that an economy can produce • Specialization and trade – Farmer Frank specializes in growing potatoes • More time growing potatoes • Less time raising cattle – Rancher Ruby specializes in raising cattle • More time raising cattle • Less time growing potatoes – Trade: 5 oz of meat for 15 oz of potatoes Comparative advantage • Absolute advantage – The ability to produce a good using fewer inputs than another producer

– In producing meat: Ruby • Ruby needs 20 min. to produce 1 oz of meat • Frank needs 60 minutes – In producing potatoes: Ruby • Ruby needs 10 min. to produce 1 oz of potatoes • Frank needs 15 minutes • Opportunity cost – Whatever must be given up to obtain some item – Measures the trade-off between the two goods that each producer faces • Comparative advantage – The ability to produce a good at a lower opportunity cost than another producer – Reflects the relative opportunity cost • Principle of comparative advantage • Each good should be produced by the individual that has the smaller opportunity cost of producing that good – Specialize according to comparative advantage • One person – Can have absolute advantage in both goods – Cannot have comparative advantage in both goods • For different opportunity costs – One person has comparative advantage in one good – The other person has comparative advantage in the other good • Opportunity cost of one good – Inverse of the opportunity cost of the other 2

• Gains from specialization and trade – Based on comparative advantage – Total production in economy rises • Increase in the size of the economic pie • Everyone is better off • Trade can benefit everyone in society – Allows people to specialize in activities in which they have a comparative advantage • The price of trade – Must lie between the two opportunity costs • The principle of comparative advantage explains: – Interdependence – Gains from trade 3

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