ECON NOTES CH. 3 INTERDEPENDENCE AND GAINS FROM TRADE Economic interdependence – trade can make everyone better off A Parable For The Modern Economy • Farmer and Rancher example I. Production Possibilities a. Panel (a) shows the production opportunities available to the farmer and the rancher. Panel (b) shows the combinations of meat and potatoes that the farmer can produce. Panel (c) shows the combinations of meat and potatoes that the rancher can produce. Both production possibilities frontiers are derived assuming that the farmer and rancher each work 8 hours per day. If there is no trade, each person's production possibilities frontier is also his or her consumption possibilities frontier b. This PPF differs from the bowed-out version in ch. 2 because the technology the farmer uses to produce meat and potatoes allows him to switch between the two goods at a constant rate, making the PPF a straight line II. Specialization and Trade a. If the farmer produces just potatoes and the rancher produces just meat, and they trade, they can each have more potatoes and more meat (impossible in the absence of trade)
b. because the farmer is better at growing potatoes than raising cattle, and the rancher is better at raising cattle than growing potatoes, they can produce more of both by specializing Comparative Advantage: The Driving Force of Specialization • in this ^^ example, the farmer is not better than the rancher at either growing potatoes nor raising cattle, so how is it better for both that they specialize? I. Absolute Advantage a. The ability to produce a good using fewer inputs than another producer b. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good c. In this example, time is the only input. The rancher has an abs adv both in producing meat and in producing potatoes because she requires less time than the farmer to produce one unit of either good c.i.