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econ 101 CHAPTER 3 and 4


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CHAPTER 3: INTERDEPENDENCE AND THE GAINS FROM TRADE Economics is the study of how societies produce and distribute goods in an attempt to satisfy the wants and needs of its members How do we satisfy our wants and needs in a global economy? o We can be economically self-sufficient o We can specialize and trade with others, leading to economic interdependence Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity o Why is interdependence the norm? Interdependence occurs because people are better off when they specialize and trade with others o What determines production and trade? Patterns of production and trade are based upon difference in opportunity costs. Production possibilities o Self-sufficiency o By ignoring each other: Each consumes what they produce The production possibilities frontier is also the consumption possibilities frontier Without trade, economic gains are diminished The PRINCIPLE OF COMPARATIVE ADVANTAGE o Differences in the costs of production determine the following: who should produce what? How much should be traded for each product? o Two ways to measure differences in costs of production: The number of hours required to produce a unit of output (for example, one pound of potatoes) The opportunity cost of sacrificing one good for another Absolute advantage - The comparison among produces of a good according to their productivity. o Describes the productivity of one person, firm, or nation compared to that of another. o The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. Opportunity cost and comparative advantage o Compares producers of a good according to their opportunity cost. Whatever must be given up to obtain some item o The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. Comparative advantage and trade o Comparative advantage and differences in opportunity costs are the basis for specialized production and trade o Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade o
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