A Parable for the Modern Economy. Imagine . . . only two goods: potatoes and meat only two people: a potato farmer and a cattle rancher What should each produce? Why should they trade?. Self-Sufficiency. By ignoring each other: Each consumes what they each produce.
By ignoring each other:
Without trade, economic gains are diminished.
Each would be better off if they specializedin producingthe product they are more suited to produce, and thentradewith each other.
The law of comparative advantage states that an individual or nation is better off producing goods and services for which it has a comparative advantage.
Differences in the costs of production determine the following:
(a) The Farmer’s Production
(b) The Rancher’s Production
Farmer’s cost Rancher’s cost
1 lb potato : ½ lb meat 1 lb potato : 8 lbs meat
Terms of Trade: 1lb potato = 3 lbs meat
1 lb meat : 2 lbs potato 1 lb meat : 1/8 lb potato
Terms of Trade:1 lb meat = 1/3 lb potato
Rancher’s consumption without trade
Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.