Chapter 3: Interdependence and Gains from Trade Production Possibilities: - If the farmer and rancher choose to be self-sufficient rather than trade with each other, then each consumes exactly what he or she produces. - In this case, the production possibilities frontier is also the consumption possibilities frontier. - Without trade, Figure 1 shows the possible combinations of meat and potatoes that the farmer and rancher can each produce and then consume Comparative Advantage: Driving Force of Specialization - absolute advantage- ability to produce a good using fewer inputs than another producer - opportunity cost- whatever must be given up to obtain some item - comparative advantage- ability to produce a good at a lower opportunity cost than another producer - When each person specializes in producing the good for which he or she has a comparative advantage, total production in the economy rises - Ex. Because the farmer and rancher have different opportunity costs, each benefits from trade by obtaining a good at a price that is lower than his or her opportunity cost of that good - Conclusion: Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage. - General rule: For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs. - imports- goods/services produced aborad, sold domestically - exports- goods/services produced domestically, sold
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