Chapter 3 Interdependence and the Gains from Trade Ten Principles of Economics • Trade can make everyone better off Parable for the Modern Economy • Two goods in the world: meat & potatoes; Two people in the world: rancher & farmer • Should they trade? • What if one was better at doing both? Production Possibilities • Shows various mixes of output that an economy can produce • Linear PPF shows tradeoffs at constant rate • Table 3-1 & Figure 3-1 Specialization and Trade • Can they both benefit from trade? • Trade allows them to consume at point outside their PPF Absolute Advantage • Being able to produce a good with a smaller quantity of inputs than someone else Opportunity Cost & Comparative Advantage • Opportunity Cost: Whatever must be given up to obtain some item - measures the trade-off between 2 goods • Comparative Advantage: ability to produce a good at a lower opportunity cost than another producer - can have an absolute advantage in both goods, but not to have comp. adv. in both Comparative Advantage & Trade • Gains from specialization & trade are based on comparative advantage • When people produce good in which they have a comp. adv., total production rises in the economy making everyone better off Price of Trade • For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs Applications of Comparative Advantage • Should US trade with other countries? • Imports vs. Exports
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