Chapter%203 - Econ 160, Vardanyan Chapter 3 Exchange and...

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Econ 160, Vardanyan 1 Chapter 3 Exchange and Markets In this chapter we will discuss the reasons why economic agents (households, firms) exchange goods and services in the markets, i.e. the rationale behind the principle of voluntary exchange. Comparative Advantage and Exchange Comparative advantage is defined as the ability of one person or a nation to produce a good at a lower opportunity cost than another person or nation. The coconuts/fish example in the book illustrates (Table 3.1 and Figure 3.1). Because Fred has a lower opportunity cost of catching (or “producing”) a fish (1/3 of coconut, compared to 1 coconut for Kate), he should specialize in fishing. Similarly, Kate should specialize in “producing” coconuts, since her opportunity cost of gathering a coconut (1 fish) is lower than that of Fred (3 fish). When Fred and Kate specialize in such a way, the total number of both coconuts (6) and fish (36) is greater than when they are self-sufficient, so the exchange can make both of them better off. This illustrates the voluntary exchange principle – a voluntary exchange between two people makes both people better off . In our example, Fred has a comparative advantage in producing fish, since his opportunity cost of doing so is lower than that of Kate. On the other hand, Kate has a comparative advantage in producing coconuts, since her opportunity cost of gathering
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This note was uploaded on 05/27/2008 for the course ECON 160B taught by Professor Michaelvardanyan during the Fall '08 term at Binghamton.

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Chapter%203 - Econ 160, Vardanyan Chapter 3 Exchange and...

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