03 Gains from Trade.pdf

Two basic ways to satisfy our needs and wants: – First, we can be economically self-sufficient; – However, social development has chosen for us to be more economically interdependent, which is reflected in widespread specialization and trade. Interdependence Every day you rely on many people from around the world, most of whom you do not know, to provide you with the goods and services you enjoy. coffee from Kenya dress shirt from China cell phone from Taiwan hair gel from Cincinnati, USA CHAPTER 3 INTERDEPENDENCE Two Fundamental Questions 1. Why does society choose specialization and trade over independence? 2. What determines who does what? Interdependence and the Gains from Trade ? Reason #1: - Limitation in resources ? Reason #2: – Preference for greater variety in consumption ? Reason #3: – Each one of us may have an “advantage” in one of the many productive activities. Example: assigning household chores Definition:“Absolute Advantage”: the ability to produce a good using fewer inputs than another producer RULE #1: When each party has an “absolute advantage” in producing one of the goods, she should specialize in the particular good in which she enjoys an absolute advantage and then through trade both would gain. BUT, Is trade still mutually desirable, if one party is better (i.e. using fewer inputs) at producing everything? Imagine an economic system with only two goods, potatoes and meat and only two people, a potato farmer and a cattle rancher A PARABLE FOR THE MODERN ECONOMY No Trade Consumption Possibilities = Production Possibilities ? Suppose the farmer and rancher choose to be self-sufficient and do not trade: ? Each consumes only what he or she can produce alone. Hence the production possibilities frontier is also the consumption possibilities frontier. ? Let us suppose they both decide to split their time equally in each activity.