Ten Principles of Economics - Part 6. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 3 INTERDEPENDENCE AND THE GAINS FROM TRADE 53 anything best. To solve this puzzle we need to look at the principle of comparative advantage. As a first step in developing this principle consider the following question In our example who can produce potatoes at lower cost the farmer or the rancher There are two possible answers and in these two answers lie both the solution to our puzzle and the key to understanding the gains from trade. ABSOLUTE ADVANTAGE One way to answer the question about the cost of producing potatoes is to compare the inputs required by the two producers. The rancher needs only 8 hours to produce a pound of potatoes whereas the farmer needs 10 hours. Based on this information one might conclude that the rancher has the lower cost of producing potatoes. Economists use the term absolute advantage when comparing the productivity of one person firm or nation to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. In our example the rancher has an absolute advantage both in producing potatoes and in producing meat because she requires less time than the farmer to produce a unit of either good. absolute advantage the comparison among producers of a good according to their productivity OPPORTUNITY COST AND COMPARATIVE ADVANTAGE There is another way to look at the cost of producing potatoes. Rather than comparing inputs required we can compare the opportunity costs. Recall from Chapter 1 that the opportunity cost of some item is what we give up to get that item. In our example we assumed that the farmer and the rancher each spend 40 hours a week working. Time spent producing potatoes therefore takes away from time available for producing meat. As the rancher and farmer change their allocations of time between producing the two goods they move along their production possibility frontiers in a sense they are using one good to produce the other. .
