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03 Gains from Trade
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.
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