Principles of Microeconomics - Reading Outline - Gains from Trade

 Name: ___________________ _____________________________ ______________________ _____________ _

READING OUTLINE

Principles of Microeconomics Microeconomics  –  Dr. Sauer 

Chapter 3: Interdependence and the Gains from Trade I. Cattle Rancher and Potato Farmer example

A. Production Possibilities A farmer and rancher each work 8 hours a day. Each can devote all his time to raising cattle, growing potatoes, or a combination of the two. The table below shows how many minutes it takes each person to produce one ounce of each product. In the blank boxes, show the math for calculating how much can be produced in 8 hours.

Farmer Rancher

Minutes to Produce 1 oz Meat Potatoes 60 min 15 min 20 min 10 min

Amount Produced in 8 hours Meat Potatoes

Given the information you filled in the right side of the table above, on the axis below  plot each person’s PPF. Be sure to label each axis. Farmer

Rancher

Suppose that each is self-sufficient. That is, each produces and consumes without trading. Suppose that the farmer chooses to produce and consume 4 oz of meat and 16 oz of potatoes. Confirm that it takes 8 hours to produce 4 oz of meat and 16 oz of potatoes. Show work.

Suppose that the rancher chooses to produce and consume 12 oz of meat and 24 oz of potatoes. Confirm that it takes 8 hours to produce 12 oz of meat and 24 oz of potatoes. Show work.

On your graphs above, indicate each producer’s chosen production level.

B. Specialization and Trade The Rancher proposes that he specialize in producing only meat and the Farmer specialize in producing only potatoes and that they do some trading. He proposes trading _____ ounces of potatoes for _____ ounces of meat. If the Rancher and Farmer trade in this way, then - the Farmer will produce _______ ounces of potatoes, trade _____ ounces of them to the Rancher and will have _______ ounces of potatoes left for himself. In return the Farmer will have ______ ounces of meat for himself. - the Rancher will produce ______ ounces of meat, trade ______ounces of it to the Farmer and will have _____ ounces of meat left for himself. In return the Rancher will have ______ ounces of potatoes for himself. On your graphs, indicate each person’s consumption level.

II. Absolute Advantage and Comparative Advantage

A. Absolute Advantage is the ability to produce:

In the farmer/rancher example, determine which person has absolute advantage in meat: potatoes: Explain how you know this.

B. Comparative Advantage is the ability to produce:

In the farmer/rancher example, calculate the per-unit opportunity cost for each. Farmer’s opp. cost of producing 1 unit of meat = Farmer’s opp. cost of producing 1 unit of o f potatoes = Rancher’s opp. cost of producing 1 unit un it of meat = Rancher’s opp. cost cost of producing 1 unit of potatoes = Determine which person has comparative advantage in: meat: potatoes: Explain how you know this.

C. Comparative Advantage and Trade

Trade can benefit everyone in society because it allows people to: D. The Trade Price For both parties to gain from trade, the trade price must be between:

In the farmer/rancher example, the price of one oz of meat is between ___ and ___ oz of potatoes. the price of one oz of potatoes is between ___ and ___oz of meat. ___________________________________________________________________________________ FYI: Legacy of Adam Smith and David Ricardo

___________________________________________________________________________________ III. Applications of Comparative Advantage

A. Should Tom Brady mow his own lawn?

B. Should the US trade with other countries?

___________________________________________________________________________________  In the News: Changing Face of International Trade