Interdependence and the Gains from Trade Individuals and nations rely on exchange as a way to specialized production and scarcity address problems caused by But this gives rise to two questions interdependence Why is the norm the pattern trade What determines and of production Interdependence and the Gains from Trade interdependence Why is the norm Interdepen 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 opportunity costs A PARABLE FOR THE MODERN ECONOMY Imagine only two goods potatoes and meat only two people a potato farmer and a cattle rancher What should each produce Why should they trade 1 Table 1 The Production Opportunities of the Farmer and Rancher Figure 1 The Production Possibilities Curve a The Farmer s Production Possibilities Frontier Meat ounces If there is no trade the farmer chooses this production and consumption 8 4 0 A 16 32 Potatoes ounces Figure 1 The Production Possibilities Curve b The Rancher s Production Possibilities Frontier Meat ounces 24 If there is no trade the rancher chooses this production and consumption 12 0 B 24 48 Potatoes ounces 2 Figure 2 How Trade Expands the Set of Consumption Opportunities a The Farmer s Production and Consumption Meat ounces Farmer s consumption with trade 8 Farmer s production and consumption without trade A 5 4 A Farmer s production with trade 0 32 16 Potatoes ounces 17 Figure 2 How Trade Expands the Set of Consumption Opportunities b The Rancher s Production and Consumption Meat ounces Rancher s production with trade 24 Rancher s consumption with trade 18 13 B B 12 0 12 24 27 Rancher s production and consumption without trade 48 Potatoes ounces Table 2 The Gains from Trade A Summary 3 Absolute Advantage The comparison among producers of a good according to their productivity absolute advantage productivity Describes the of one person firm or nation compared to that of another The producer that requires a smaller quantity of inputs to produce a good is said to have an in producing that good absolute advantage Absolute Advantage The Rancher needs only 10 minutes to produce an ounce of potatoes whereas the Farmer needs 15 minutes The Rancher needs only 20 minutes to produce an ounce of meat whereas the Farmer needs 60 minutes The Rancher has an absolute advantage in the production of Opportunity Cost and Comparative Advantage Compares producers of a good according to opportunity cost their Whatever must be given up to obtain some item The producer who has the smaller opportunity cost of producing a good is said to have a comparative advtg in producing that good 4 Comparative Advantage and Trade The Rancher s opportunity cost of an ounce of potatoes is an ounce of meat whereas the Farmer s opportunity cost of an ounce of potatoes is an ounce of meat The Rancher s opportunity cost of a pound of meat is only 4 ounces of potatoes while the Farmer s opportunity cost of an ounce of meat is only 2 ounces of potatoes Comparative Advantage and Trade so the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes Specialization and Trade The Farmer and the Rancher Specialize and Trade Each would be better off if they specialized in producing the product they are more suited to produce and then trade with each other The farmer should produce potatoes The rancher should produce meat 5 Comparative Advantage and Trade and differences in opportunity costs are the basis for specialized production and trade Whenever potential trading parties have differences in they can each benefit from trade Comparative Advantage and Trade Benefits of Trade Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a 6