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Chapter 3

Chapter 3 EC120.docx

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Department
Economics
Course
EC120
Professor
Peter Sinclair
Semester
Fall

Description
EC120 Chapter 3-Interdependence and The Gains from Trade Week 2 A Parable for the Modern Economy -Each country should produce what they are good at and trade it with other countries in order to get a variety in their lifestyle. -Self sufficiency is not good. -Ex. A meat farmer and a potato farmer exist. The meat farmer can only grow meat and the potato farmer only potatoes. After months of just eating potato and meat they would become sick of it and therefore must trade. Production Possibilities Specialization and Trade -Trade allows you to specialize and therefore consume more without working more because of what you trade with other countries. EC120 Chapter 3-Interdependence and The Gains from Trade Week 2 Comparative Advantage: The Driving Force of Specialization Absolute Advantage -Absolute advantage-the comparison among producers of a good according to their productivity -The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good Opportunity Cost and Comparative Advantage -Instead of comparing inputs we can compare opportunity costs -Comparative Advantage-the comparison among producers of a good according to their opportunity cost. -Although it is possible for one person to have an absolute advantage in both goods, it is impossible for one person to have a comparative advantage in both goods -Because the opportunity cost of one good is the inverse of the opportunity cost of the other, if a person’s opportunity cost of one good is relatively high, his opportunity cost of the other good must be relatively low. Comparative Advantage and Trade -The gains from specialization and trade are based not on absolute advantage but rather on comparative advantage -When each person s
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