E201 Ch3 Notes - CHAPTER 3 INTERDEPENDENCE AND THE GAINS FROM TRADE An Example of Specialization and Trade Assume that in the economy there are only two

# E201 Ch3 Notes - CHAPTER 3 INTERDEPENDENCE AND THE GAINS...

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CHAPTER 3 – INTERDEPENDENCE AND THE GAINS FROM TRADE An Example of Specialization and Trade Assume that in the economy there are only two goods (meat and potatoes) and two agents (rancher and farmer). They gain from specialization and trade. The Farmer Whenever the farmer spends 1 hour less producing meat and 1 hour more producing potatoes, he reduces his output of meat by 1 ounce and raises his output of potatoes by 4 ounces. Therefore farmer’s opportunity cost of producing 1 ounce of potatoes is ¼ ounce of meat. If he devotes all eight hours of work in a day producing meat, he maximizes the production (and consumption) of meat. His maximum consumption of meat is 8 ounces per day and no potatoes (vertical intercept). Similarly, his maximum consumption of potatoes is 32 ounces and no meat (horizontal intercept). Assuming that the technology is such that the farmer can switch from the production of meat to the production of potatoes at a constant rate, then the frontier is the line between the two intercepts (see Panel b, Figure 1 page 51). The Rancher Whenever the rancher spends 1 hour less producing meat and 1 hour more producing potatoes, he reduces his output of meat by 3 ounces and raises his output of potatoes by 6 ounces. Therefore rancher’s opportunity cost of producing 1 ounce of potatoes is ½ ounce of meat. The rancher’s maximum consumption of meat is 24 ounces per day and no potatoes (vertical intercept). Similarly, his maximum consumption of potatoes is 48 ounces and no meat (horizontal intercept). Assuming that the technology is such that the rancher can

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