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Economics Final Summary

Terms in this set (134)

If individuals have different preferences, exchanging goods that they value less for goods that they value more increases the well-being of all parties to such exchanges. As long as individuals freely trade, exchange is guided by an invisible hand--both parties to the exchange will be better off. Thus, exchagne is a way of coordinating competing interests.

Exchange allow individuals to specialize. Specialization depends upon relative production costs: the cost to one person of producing something relative to the cost of producing the same thing to someone with whom the person might trade. That is, specialization depends on comparative advanatage. An individual has a comparative advantage in the production of a good if his or her relative costs of producing that good are lower than those of someone with whom the individual might trade.

Specialization consistent with comparative advantage will increase the amount of goods and services available to an economy without using additional resources. Hence, specialization coordinates competing interests in a useful and productive way. Moreover, the gains to an individual from specialization do not depend upon being absolutely better at some activity than other individuals. All that matters is that an individual be relatively better or have a comparative advantage. So long as individuals are different from one another, each will have a comparative advantage.

Exchange and specialization lead to a kind of spontaneous order, in which competing interests are cooridanted in ways that have the potential to beefit all participants.