ECON202, Maclachlan, Spring Interdependence & Gains from Trade Week 2

ECON202, Maclachlan, Spring Principle #5 Trade can make everyone better off.

ECON202, Maclachlan, Spring Alternative to Trade: Self Sufficiency

ECON202, Maclachlan, Spring Autarky A policy of national self-sufficiency and nonreliance on imports or economic aid.

ECON202, Maclachlan, Spring Mercantilism A country should aim to run trade surpluses and increase its monetary assets.

ECON202, Maclachlan, Spring Adam Smith ( ) Critic of mercantilism. Countries should specialize and trade. Specialize where there’s an ABSOLUTE ADVANTAGE

ECON202, Maclachlan, Spring ABSOLUTE ADVANTAGE A region has an absolute advantage if it takes fewer resources to produce a good there than elsewhere. Coffee in Columbia. Computer software in Silicon Valley.

ECON202, Maclachlan, Spring David Ricardo ( ) Theory of comparative advantage. Even without an absolute advantage a region can trade to the benefit of all parties.

Table 1 The Production Opportunities of the Farmer and Rancher Copyright © 2004 South-Western

ECON202, Maclachlan, Spring Figure 1a The Production Possibilities Frontier

ECON202, Maclachlan, Spring Figure 1b The Production Possibilities Frontier

ECON202, Maclachlan, Spring Rancher’s Deal for Farmer Farmer stops producing meat and specializes in potatoes. In a day he can produce … 32 oz of potatoes. Farmer sells 15 oz to Rancher for 5 oz of meat. Farmer ends up with … = 17 oz of potatoes and 5 oz of meat. Farmer is better off.

ECON202, Maclachlan, Spring Rancher’s Plan Spend 6 hrs producing 18 oz of meat. Sell 5 oz and keep 13 oz of meat. Spend 2 hrs producing 12 oz of potatoes. Total potato consumption 15 oz + 12 oz = 27 oz. Total consumption: 13 oz of meat and 27 oz of potatoes.

ECON202, Maclachlan, Spring Figure 2a How Trade Expands the Set of Consumption Opportunities

ECON202, Maclachlan, Spring Figure 2b How Trade Expands the Set of Consumption Opportunities

Table 2 The Gains from Trade: A Summary Copyright © 2004 South-Western

ECON202, Maclachlan, Spring How to determine comparative advantage Look for that good or service for which the OPPORTUNITY COST is lowest. The opportunity cost is the cost of producing in terms of an alternative good.

Table 3 The Opportunity Cost of Meat and Potatoes Copyright © 2004 South-Western

ECON202, Maclachlan, Spring Country Example Two countries: the U.S. and Japan Two goods: computers and wheat One resource: labor, measured in hours

ECON202, Maclachlan, Spring Production Possibilities in the U.S. The U.S. has 50,000 hours of labor available for production, per month. Producing one computer requires 100 hours of labor. Producing one ton of wheat requires 10 hours of labor.

ECON202, Maclachlan, Spring , ,000 2,000 1,000 3, Computers Wheat (tons) The U.S. PPF The U.S. has enough labor to produce 500 computers, or 5000 tons of wheat, or any combination along the PPF.

ECON202, Maclachlan, Spring , ,000 2,000 1,000 3, Computers Wheat (tons) The U.S. Without Trade Suppose the U.S. uses half its labor to produce each of the two goods. Then it will produce and consume 250 computers and 2500 tons of wheat.

ECON202, Maclachlan, Spring Derive Japan’s PPF Japan has 30,000 hours of labor available for production, per month. Producing one computer requires 125 hours of labor. Producing one ton of wheat requires 25 hours of labor. 23 Use the following information to draw Japan’s PPF. Your graph should measure computers on the horizontal axis.

ECON202, Maclachlan, Spring Computers Wheat (tons) 2,000 1, Japan’s PPF Japan has enough labor to produce 240 computers, or 1200 tons of wheat, or any combination along the PPF.

ECON202, Maclachlan, Spring Japan Without Trade Computers Wheat (tons) 2,000 1, Suppose Japan uses half its labor to produce each of the two goods. Then it will produce and consume 120 computers and 600 tons of wheat.

ECON202, Maclachlan, Spring Consumption With and Without Trade Without trade, –U.S. consumers get 250 computers and 2500 tons wheat. –Japanese consumers get 120 computers and 600 tons wheat. We will compare consumption without trade to consumption with trade. First, we need to see how much of each good is produced and traded by the two countries.

ECON202, Maclachlan, Spring Production under trade Production under trade 1.Suppose the U.S. produces 3400 tons of wheat. How many computers would the U.S. be able to produce with its remaining labor? Draw the point representing this combination of computers and wheat on the U.S. PPF. (slide 20) 2.Suppose Japan produces 240 computers. How many tons of wheat would Japan be able to produce with its remaining labor? Draw this point on Japan’s PPF. (slide 23) 27

ECON202, Maclachlan, Spring , ,000 2,000 1,000 3, Computers Wheat (tons) U.S. Production With Trade Producing 3400 tons of wheat requires 34,000 labor hours. The remaining 16,000 labor hours are used to produce 160 computers.

ECON202, Maclachlan, Spring Japan’s Production With Trade Producing 240 computers requires all of Japan’s 30,000 labor hours. Computers Wheat (tons) 2,000 1, So, Japan would produce 0 tons of wheat.

ECON202, Maclachlan, Spring International Trade Exports: goods produced domestically and sold abroad Imports: goods produced abroad and sold domestically

ECON202, Maclachlan, Spring Consumption under trade Consumption under trade How much of each good is consumed in the U.S.? Plot this combination on the U.S. PPF. How much of each good is consumed in Japan? Plot this combination on Japan’s PPF. 31 Suppose the U.S. exports 700 tons of wheat to Japan, and imports 110 computers from Japan. (So, Japan imports 700 tons wheat and exports 110 computers.)

ECON202, Maclachlan, Spring , ,000 2,000 1,000 3, Computers Wheat (tons) U.S. Consumption With Trade computerswheat produced imported1100 – exported0700 = amount consumed

ECON202, Maclachlan, Spring Japan’s Consumption With Trade Computers Wheat (tons) 2,000 1, computerswheat produced imported0700 – exported1100 = amount consumed

ECON202, Maclachlan, Spring Trade Makes Both Countries Better Off U.S. consumption without trade consumption with trade gains from trade computers wheat2,5002, Japan consumption without trade consumption with trade gains from trade computers wheat