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THE CASE FOR TRADE: Comparative Advantage Trade (Interdependence) Instead of Protectionism (Self-Sufficiency)

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Presentation on theme: "THE CASE FOR TRADE: Comparative Advantage Trade (Interdependence) Instead of Protectionism (Self-Sufficiency)"— Presentation transcript:

1 THE CASE FOR TRADE: Comparative Advantage Trade (Interdependence) Instead of Protectionism (Self-Sufficiency)

2 Adam Smith, Wealth of Nations, 1776 It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The taylor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a taylor.

3 David Ricardo, On the Principle of Political Economy and Taxation, 1817 Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats, he can only exceed his competitor by one-fifth or 20 percent, and in making shoes he can excel him by one- third or 33 percent;--will it not be for the interest of both that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats?

4 Basic Concept: One should do that which one does best One = a Person One = a Business One = a Region One = a City One = a State One = a Nation

5 Absolute Advantage... Producing more outputs (goods and services) with a given number of inputs than another Producing an output with fewer inputs (resources—land, labor, capital, entrepreneurship) than another

6 Comparative Advantage... When one has the absolute advantage in producing both products, then each should produce that which they produce at the lowest opportunity cost! Both parties will benefit from specialization and trade.

7 Comparative Advantage Rule Specialization and trade are beneficial if there is a difference In opportunity costs.

8 CPA vs. Painter Makes $50/hr. Can paint house in 30 hrs. Makes $15/hr. Can paint house in 40 hrs. CPAPainter

9 CPA vs. Painter Cost of hiring painter = 40 hours x $15/hr. = $600 Cost of CPA painting house = 30 hours x $50/hr. = $1500 Although CPA can paint house better than painter, she should still hire painter

10 CPA vs. Painter Cost of hiring CPA to do tax return = 2 hrs. x $50/hr. = $100 Cost of Painter doing his own tax return = 10 hrs. x $15/hr. = $150 CPA does BOTH better than painter – she should still hire painter to paint house while she does tax returns

11 Hatfields and McCoys 8 hrs./bushel of corn 10 hrs./yd. of cloth 18 hrs. for both 16 hrs. for 2 bushels of corn 15 hrs./bushel of corn 12 hrs./yd. of cloth 27 hrs. for both 24 hrs. for 2 yds. of cloth Hatfields McCoys

12 Comparative Advantage Hatfields – 1 corn =.8 cloths (8/10) McCoys – 1 corn = 1.25 cloths (15/12) Hatfields – 1 cloth = 1.25 corns (10/8) McCoys – 1 cloth =.8 corns (12/15) CornCloth

13 Hatfields and McCoys Yes, both families gain Absolute advantage in corn – Hatfields Absolute advantage in cloth – Hatfields Comparative advantage in corn – Hatfields (1 corn =.8 cloths) Comparative advantage in cloth – McCoys (1 cloth =.8 corns)

14 Comparative Advantage Problems Does the problem show increasing opportunity costs or constant costs? Is it an output problem or an input problem? What are the ratios? What are the terms of trade?

15 Why a nation trades and produces both products for domestic consumption... If there are increasing opportunity costs Instead of constant opportunity costs Then At some point the trade ratios of the two countries are equal, and there is no need to trade.

16 Inputs per output: Opportunity Cost Under — IOU Labor Hrs. per Comput er Oppor. Cost of One Computer Labor Hrs. per VCR Oppor. Cost of One VCR USA3 hours1C : 3/2=1.5V 2 hours 1V : 2/3=.67C Japan3 hours1C : 3/1=3V 1 hour1V : 1/3=.33C

17 Which country has the lowest opportunity cost for computers? (USA--only 1.5 VCR’s per computer) Which country has the lowest opportunity cost for VCR’s? (Japan--only.33 of a computer per VCR) What should be the terms of trade? (1 computer for more than 1.5 VCR’s and less than 3 VCR’s

18 Outputs per input: Opportunity Cost Over-- OOO Co mp- ters Oppor. Cost of One Computer Toma - toes Oppor. Cost of One Tomato USA501C=5000/5 0=100T 50001T=50/5000 =.01C Mexico101C=4000/1 0=400T 40001T=10/4000 =.0025C

19 Which country has the lowest opportunity cost for computers? (USA – only 100 units of tomatoes) Which country has the lowest opportunity cost for tomatoes? (Mexico—only.0025 of one computer) What should be the terms of trade? (1 computer for more than 100 tomatoes and less than 400 tomatoes)

20 Results of Specialization & Trade More efficient allocation of world resources More goods and services (output) for all nations More world competition which deters monopoly More domestic firms using lower cost production techniques More consumer choices More innovation in products and processes More negotiating between nations

21 Causes of Economic Growth More and better resources New technology Higher productivity More international trade? Capita Goods And Servicesl Consumer Goods & Services


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