Chapter 3 - Chapter 3 Interdependence and the Gains from...

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Chapter 3 Interdependence and the Gains from Trade Resources available to meet our wants and needs are scarce. In economics we study how people make choices under scarcity constraints. In making a choice, people try to maximize their economic surplus (benefit – cost). We will see how specialization of (countries, regions or individuals), based on comparative advantage, can be beneficial to all parties because it uses available resources in such away that maximize benefit and minimize cost. A society where everyone produces his own good and services produces less than a society where people specialize in particular goods and services, then satisfy their needs by trading among themselves. Specialization and trade increase total production and consumption. This chapters shows how specialization of (countries, regions or individuals) in the production of goods and services and then trade (economic interdependence) is better than for each (country, region or individual) to produce its goods and services; be economically self-sufficient. How do we satisfy our wants and needs in a global economy? We can be economically self-sufficient. 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. But this gives rise to two questions: Why is interdependence the norm? What determines production and trade? Why is interdependence the norm? Interdependence occurs because people are better off when they specialize and trade with others. What determines the pattern of production and trade? Patterns of production and trade are based upon differences in opportunity costs. A PARABLE FOR THE MODERN ECONOMY The following story will show us the benefit from specialization and trade. Imagine an economic system with only two goods, potatoes and meat and only two people, a potato farmer and a cattle rancher What should each person produce? Why should these people trade? Suppose that:
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The farmer and the rancher each work 8 hours a day and can devote this time to growing potatoes, raising cattle, or combination of both. The time it takes the farmer and the rancher to produce one ounce of potato and once ounce of meat is shown in the table below. Also shown are the amounts of meat and potatoes that the farmer and rancher each can produce in 8 hours. . The information above enables us to draw the production possibilities frontier for the farmer and for the rancher. The PPF for one person is not bowed out from the origin as we have seen in the previous chapter. This is because we assume that the farmer and the rancher technology for producing meat and potatoes allows them to switch between producing one good and the other at a constant rate. Therefore, the PFF for the rancher and the farmer are linear. Of course the linear PPF is still negatively sloped that shows the trade off and the opportunity cost concepts. The following table shows the production possibilities for the farmer given that he has 8
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This note was uploaded on 03/08/2011 for the course ECON 201 taught by Professor Azzam during the Spring '11 term at Alabama.

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Chapter 3 - Chapter 3 Interdependence and the Gains from...

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