Chapter+3+Independence+and+the+Gains+from+Trade+JBS

=**Chapter 3 Interdependence and the Gains from Trade JBS ** =

Key Terms:
 **Absolute advantage** - the ability to produce a good using fewer inputs than another producer


 * Opportunity cost** - whatever must be given up to obtain some item


 * Comparative advantage** - the ability to produce a good at a lower opportunity cost than another producer




People have tendency to only trade when both sides of the trade get the benefit. But because people always try to maximize their profit, they would try to trade so that both side would get the most profit out of the trade. Because of this tendency of producers, the producers will "**specialize**," meaning that they would only produce a specific product that they have comparative advantage in.

To explain this chapter, a scenario will be applied. 




 In order to compare the production possibilities of two producers to determine who has **comparative advantage** in which, one first needs some data. The data should state how many both producers can produce in a certain amount of time. Now looking at the production possibilities frontier, one might notice that theses are not curved out. This is because the amount of ketchup produced depends on the amount of mustard that is produced. They can both choose to be self-sufficient, because they both have the ability to produce both products. Yet if they want to save time and money by trading, which would also maximize the profit gained in the same amount of time, they will choose to trade.




When deciding who will be specialized in which product,the essential question really becomes "Who can produce product A at a lower cost?" and the one who actually can will have an advantage. There are two methods to answer the question, and one is by using the absolute advantage.

//Absolute advantage, as defined in the key terms section, is the ability to produce a good using fewer inputs than another producer.// This simply means if one can produce more in the same amount of time,where time is the only input, and that person will have the absolute advantage no mater what. The value that determines the absolute advantage can change depending on which input is used. Using the example, Tom would have the absolute advantage in both cases because Tom can definitely produce more in the same amount of time.

Another method is by using the comparative advantage. This method is more used because it is possible for one producer to have absolute advantage in both items, like Tom in our case, but it is //comparative advantage can be measured by using the opportunity cost//. Opportunity cost, as stated in chapter 1, is whatever must be given up to obtain some item.Let's take a look at the opportunity cost of this example first. 



 To analyze this information, we need to first talk about how to get the opportunity cost. Opportunity cost is basically calculating what one could have gotten if one produced another product instead of 1 unit of a product. Let's look at an example. In this graph, it states that the opportunity cost of 1 bottle of ketchup is 1/2 bottle of mustard. This means that in the same amount of time that Bob could produce 1 bottle of ketchup, he could have produced 1/2 bottle of mustard. Like this, Tom could have produced 1/3 bottle of mustard during the time he was making 1 bottle of ketchup. Here, who will have the comparative advantage?

Tom will have the comparative advantage in producing ketchup, because he has to give up less amount of mustard. Like this the one that has LESS opportunity cost will have the comparative advantage. Applying this knowledge, it is shown that Bob will have the comparative advantage in the production of mustard.

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**<span style="color: #ffc800; font-family: Tahoma,Geneva,sans-serif;">Trade **<span style="font-family: Tahoma,Geneva,sans-serif;">
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