A PARABLE FOR THE MODERN ECONOMY

To understand why people choose to depend on others for goods and services and how this choice improves their lives, let’s look at a simple economy. Imagine that there are two  goods in the world  meat and potatoes. And there are two people in the world a cattle rancher and a potato farmer each of whom would like to eat both meat and potatoes.

The gains from trade are most obvious if the rancher can produce only meat and the farmer can produce only potatoes. In one scenario, the rancher and the farmer could choose to have nothing to do with each other. But after several months of eating beef roasted, boiled, broiled, and grilled, the rancher might decide that self-sufficiency is not all it’s cracked up to be. The farmer, who has been eating potatoes mashed, fried, baked, and scalloped, would likely agree. It is easy to see that trade would allow them to enjoy greater variety. Each could then have a steak with a baked potato or a burger with fries.

Although this scene illustrates most simply how everyone can benefit from trade, the gains would be similar if the rancher and the farmer were each capable of producing the other good, but only at great cost. Suppose, for example, that the potato farmer is able to raise cattle and produce meat, but that he is not very good at it. Similarly, suppose that the cattle rancher is able to grow potatoes but that her land is not very well suited for it. In this case, it is easy to see that the farmer and the rancher can each benefit by specializing in what he or she does best and then trading with the other.

The gains from trade are less obvious, however, when one person is better at producing every good. For example, suppose that the rancher is better at raising cattle and better at growing potatoes than the farmer. In this case, should the rancher or farmer choose to remain self sufficient? Or is there still reason for them to trade with each other? To answer this question, we need to look more closely at the factors that affect such a decision.

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