MORE ON PRODUCTION POSSIBILITIES & SUPPLY/DEMAND INTERNATIONAL TRADE

Absolute versus Comparative Productivity Advantage  Absolute productivity advantage: held by a country that produces more of a certain good per hour worked than another  Comparative productivity advantage (or comparative advantage): held by a country that has lower opportunity costs of producing a good than its trading partners do  Comparative advantage allows a country that lacks absolute advantage to sell its products abroad

Output per Hour Worked ProductOutput per hour worked Cars20.5 Steel3 tons1 ton Japan has an absolute advantage in both cars (2>0.5) and steel (3>1), yet it can still gain from trade, as can Mexico Once trade opens, the world price of cars will be between one and three tons of steel per car P wc = world price 1(tons/car) < P wc < 2(tons/car)

Market for cars faced by Japanese producers Demand for cars Supply of cars World price of cars Price of cars Quantity of cars The world price of cars is higher than the equilibrium price in Japan--- Japan will export cars

Market for cars faced by Mexican producers Demand for cars Supply of cars World price of cars Price of cars Quantity of cars The world price of cars is lower than the equilibrium price in Mexico--- Mexico will import cars to augment their supply Imports Domestic supply

Comparative versus Competitive Advantage   Comparative advantage = competitive (commercial) advantage when the prices of both inputs and outputs are an accurate indication of their relative scarcity   Comparative advantage  competitive advantage when the markets fail to correctly value the price of inputs and outputs Imbalances result from government policies, such as subsidies or protection

 Restructuring may occur in an economy – or policy may be imposed that restructures the economy  Some industries or sectors then may grow, but others may not grow or vanish In the Ricardian model, trade opening moved labor from bread to steel productionIn the Ricardian model, trade opening moved labor from bread to steel production restructuring improved U.S. overall economic welfare but made its bread industry diminish somerestructuring improved U.S. overall economic welfare but made its bread industry diminish some If trade results in net gain (in an increase of the consumption bundle), a country will be better off by trading; however, some sectors may still loseIf trade results in net gain (in an increase of the consumption bundle), a country will be better off by trading; however, some sectors may still lose

Impacts of Comparative Advantage  Comparative advantage allows gains from trade to occur  However, when a nation moves along its PPC toward a new mix of industries to exploit its comparative advantage, the transition period may hurt some – some nations initiate mobility training and transition policies   Economic restructuring caused by trade opening produces higher living standards; however, in the short-term, restructuring is often costly

. PRODUCTION POSSIBILITIES IN THE U.S. AND BRAZIL IN PRODUCING WHEAT AND SUGAR --- INCREASING COST CASE sugar wheat sugar BRAZIL USA BRAZIL AND THE U.S. BOTH PRODUCE WHEAT AND SUGAR – BRAZIL IS MORE PRODUCTIVE IN PRODUCING WHAT? THE U.S. IS MORE PRODUCTIVE IN PRODUCING WHAT? TERMS OF TRADE PRODUCTION POSSIBILITIES CURVE

sugar wheat sugar BRAZILUSA NOW PLACE THE COMMUNITY INDIFFERENCE CURVES (CIC) FOR THE U.S. AND BRAZIL THE TANGENCY OF THE CIC CURVES WITH BOTH THE TERMS OF TRADE AND THE PPC GIVES THE EQUILIBRIUM AMOUNT OF WHEAT AND SUGAR TO BE PRODUCED AND CONSUMED IN EACH NATION WITHOUT TRADE BETWEEN NATIONS (A LEVEL OF a OF WHEAT AND A LEVEL OF b OF SUGAR IN THE U.S. AND A LEVEL OF c OF WHEAT AND A LEVEL OF d OF SUGAR IN BRAZIL a b c d

Trade conditions sugar wheat NOW ALLOW TRADE TO OCCUR BETWEEN BRAZIL AND THE U.S THE TERMS OF TRADE CHANGES AS SHOWN (THE DOUBLE LINE REFLECTS PRODUCTION,WHILE THE SOLID LINE REFLECTS CONSUMPTION) wheat sugar BRAZILUSA WITH TRADE, THE TERMS OF TRADE CHANGES SLIGHTLY --- EACH NATION MOVES OUT ONTO A HIGHER CIC (THE DASHED CIC’s) ---- PRODUCTION BECOMES THE DOUBLE LINE IN EACH NATION CASE ---- IN BRAZIL, PRODUCTION OF SUGAR INCREASES AND PRODUCTION OF WHEAT DECREASES --- IN THE U.S., WHEAT PRODUCTION INCREASES CONSIDERABLY AND SUGAR PRODUCTION IS DECREASED CONSIDERABLY IN BRAZIL, WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES SLIGHTLY IN THE U.S., WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES

TRADE INDUCES CHANGES IN PRODUCTION AND CONSUMPTION GIVEN THE TECHNOLOGY(PPC) AND THE PREFERENCES EXPRESSED IN THE CIC sugar wheat UNDER TRADE CONDITIONS, BOTH BRAZIL AND THE U.S. ARE NOT LIMITED BY THEIR PRODUCTION TECHNOLOGIES -- TRADE ALLOWS BOTH NATIONS TO INCREASE ECONOMIC WELFARE BY MOVING OUT TO A HIGHER CIC wheat sugar BRAZILUSA WITH TRADE, THE TERMS OF TRADE CHANGES SLIGHTLY --- EACH NATION MOVES OUT ONTO A HIGHER CIC (THE DASHED CIC’s) ---- PRODUCTION BECOMES THE DOUBLE LINE IN EACH NATION CASE ---- IN BRAZIL, PRODUCTION OF SUGAR INCREASES AND PRODUCTION OF WHEAT DECREASES --- IN THE U.S., WHEAT PRODUCTION INCREASES CONSIDERABLY AND SUGAR PRODUCTION IS DECREASED CONSIDERABLY IN BRAZIL, WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES SLIGHTLY IN THE U.S., WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES