Principles of Macroeconomics
Principles of Macroeconomics ECON 1010
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This 10 page Class Notes was uploaded by Hallie Kuphal on Wednesday October 28, 2015. The Class Notes belongs to ECON 1010 at University of Wyoming taught by Staff in Fall. Since its upload, it has received 14 views. For similar materials see /class/230363/econ-1010-university-of-wyoming in Economcs at University of Wyoming.
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Burgess Principles of Macro Economics Econ 10101 1 Topic 3 Interdependence and the Gains from Trade 1What are the Benefits of Trade Case Study Example The Production Opportunities of a Farmer and a Rancher Self Sufficiency Specialization and Trade 2The Principle of Comparative Advantage Absolute Advantage Comparative Advantage Case Study Example Comparative Advantage and Trade Summary 3Applications of Comparative Advantage 4 Summary Burgess Principles of Macro Economics Econ 10101 2 1 What are the Benefits from Trade Economics is the study of how societies produce and distribute goods in an attempt to satisfy the wants and needs of its members How do we satisfy our wants and needs in a global economy oWe can be economically selfsufficient oWe can specialize and trade with others leading to economic interdependence Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity Burgess Principles of Macro Economics Econ 10101 This gives rise to two questions oWhy is interdependence the norm oWhat determines production and trade Interdependence occurs because people are better off when they specialize and trade with others Patterns of production and trade are based upon differences in opportunity costs Burgess Principles of Macro Economics Econ 10101 4 11 Case Study Example The Production Opportunities of a Farmer and a Rancher 0 Assume only two goods potatoes and meat only two people a potato farmer and a cattle rancher o What should each produce o Why should they trade 12 SelfSufficiency By ignoring each other o Each consumes what they each produce o The production possibilities frontier is also the consumption possibilities frontier Without trade economic gains are diminished 13 Specialization 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 Burgess Principles of Macro Economics Econ 10101 2 The Principle of Comparative Advantage o Who should produce What o How much should be traded for each product This depends on the differences in the costs of production o The number of hours required to produce a unit of output for example one pound of potatoes o The opportunity cost of sacrificing one good for another Burgess Principles of Macro Economics Econ 10101 21 Absolute Advantage oDescribes the productivity of one person firm or nation compared to that of another oThe producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good 22 Comparative Advantage oCompares producers of a good according to their opportunity cost oThe producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good Burgess Principles of Macro Economics Econ 10101 23 Case Study Example Comparative Advantage and Trade oWho has the absolute advantage The farmer or the rancher oWho has the comparative advantage The farmer or the rancher Absolute Advantage oThe Rancher needs only 8 hours to produce a pound of potatoes Whereas the Farmer needs 10 hours oThe Rancher needs only 1 hour to produce a pound of meat Whereas the Farmer needs 20 hours Comparative Advantage oThe Rancher s opportunity cost of a pound of potatoes is 8 pounds of meat Whereas the Farmer s opportunity cost of a pound of potatoes is 12 pound of meat oThe Rancher s opportunity cost of a pound of meat is only 1 8 pound of potatoes While the Farmer s opportunity cost of a pound of meat is 2 pounds of potatoes Burgess Principles of Macro Economics Econ 10101 24 Summary oComparative advantage and differences in opportunity costs are the basis for specialized production and trade oWhenever potential trading parties have differences in opportunity costs they can each benefit from trade Therefore trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage Burgess Principles of Macro Economics Econ 10101 9 3 Applications 31 Adam Smith and Trade In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations Adam Smith performed a detailed analysis of trade and economic interdependence which economists still adhere to today 32 David Ricardo and Trade In his 1816 book Principles of Political Economy and Taxation David Ricardo developed the principle of comparative advantage as we know it today 33 Should Tiger Woods Mow His Own Lawn 34 Should the United States Trade with other Countries Burgess Principles of Macro Economics Econ 10101 10 4 Summary olnterdependence and trade allow people to enjoy a greater quantity and variety of goods and services oThe person who can produce a good with a smaller quantity of inputs has an absolute advantage oThe person with a smaller opportunity cost has a comparative advantage oThe gains from trade are based on comparative advantage not absolute advantage oComparative advantage applies to countries as well as to people