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3 (15) - 32 pan 1 WHAT IS ECONOMICS FIGURE 2-5 Comparative...

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Unformatted text preview: 32 pan 1 WHAT IS ECONOMICS? FIGURE 2-5 Comparative Advantage and Gains From Trade (a) Tom's Production and tonsumptlon (h) Hank’s Production and Consumption Quantity Quantity of coconuts of coconuts 3i] Tom’s consumption m'thout trade Hook's production with trade Tom's consumption With trade Hank's consumption / with trade Tom's / . . production _ ..... Hank's consumption with trade . . . ‘ : Without trade Hankh PPF Quantity of fish Quantity of fish By specializing and trading, the two castaways can produce cmnporative advantage in coconuts—specializes in gather- and consume more of both goods. Tom specializes in ing coconuts. The result is that each castaway can consume catching fish. his comparative advantage. and Hank— more of both goods than either could without trade. who has an absolute disadvantage in both goods but a One point of clarification before we proceed further. You may have wondered why Tom and Hank traded 10 fish for ‘10 coconuts. Why not some other deal, like trad- ing ‘1 5 coconuts for 5 fish? The answer to that question has two parts. First. there may indeed be deals other than ‘10 fish for 10 coconuts that Tom and Hank are willing to agree to. Second. there are some deals that we can. however. safely rule out—one like 15 coconuts for 5 fish. To understand why, reexamine Table 2-1 and consider Hank first. When Hank works on his own without trading with Tom, his opportunity cost of 1 fish is 2 coconuts. Therefore, it’s clear that Hank will not accept any deal with Tom in which he must give up more than 2 coconuts per fish—otherwise. he’s better off not trading at all. So we can rule out a deal that requires Hank to pay 3 coconuts per fish—such as trading 15 coconuts for 5 fish. But Hank will accept a trade in which he pays less than 2 coconuts per fish—such as paying ‘1 coconut for 1 fish. Likewise. Torn will reject a deal that requires him to give up more than 4/3 of a fish per coconut. For example, Tom would refuse a trade that required him to give up 10 fish for 6 coconuts. But he will accept a deal where he pays less than 4/3 of a fish per coconut— and ‘1 fish for 1 coconut works. You can check for yourself why a trade of 1 fish for 1.5 coconuts would also be acceptable to both Tom and Hank. So the point to remem- ber is that Tom and Hank will be willing to engage in a trade only if the "price” of the good each person is obtaining from the trade is less than his own opportunity cost of producing the good himself. Moreover, that's a general statement that is true whenever two parties trade voluntarily. The story of Tom and Hank clearly simplifies reality. Yet it teaches us some very important lessons that apply to the real economy. too. First. the model provides a clear illustration of the gains from trade: by agreeing to specialize and provide goods to each other. Tom and Hank can produce more and therefore both be better off than if they tried to be self-sufficient. Second. the model demonstrates a very important point that is often overlooked in real-world arguments: as long as people have different opportunity costs, everyone has a comparative admntage in something, and everyone has a comparative disadvantage in something. ...
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