Why Nations Trade? If we are better at making everything, why would we trade with anyone else?

Resource Distribution  The Factors of Production  Land  All natural resources  Labor  Work and skills of people  Capital  Objects used to produce other goods  Entrepreneurs  The people who put it all together

Resource Distribution  As you would expect resources are not distributed equally between countries.  This is true of ALL Factors of Production  Because of this countries should trade

Absolute Advantage  Absolute advantage  The ability to produce more of a product using a given amount of resources  For example: We have Todd and Wendy

Absolute Advantage  Given more than enough supplies  And one hour in which to build birdhouses

Absolute Advantage  Todd can build 2 Birdhouse  Wendy can build 8 Birdhouses

Absolute Advantage  Thus we say that Wendy has an Absolute Advantage over Todd when it comes to making Birdhouses.  Things to Remember: 1.Time is a resource (It is a part of “labor”) 2.Absolute Advantage is an advantage over someone else at making that one product 3.A product can be a good or service

Comparative Advantage  The ability to produce a product most efficiently given all the other products that could be produced (w/ lowest opportunity cost)  Example: Given more than enough supplies and given one hour to work...

Comparative Advantage  Todd can make two kites  Wendy can make four kites

Comparative Advantage  What is Todd’s opportunity costs?  1 hour = 2 birdhouses  1 hour = 2 kites  2 birdhouses = 2 kites  1 birdhouse = 1 kite  Opportunity cost of 1 birdhouse  1 Kite  Opportunity cost of 1 kite  1 birdhouse

Comparative Advantage  What is Wendy’s opportunity costs?  1 hour = 8 birdhouses  1 hour = 4 kites  8 birdhouses = 4 kites  1 birdhouse = ½ kite  Opportunity cost of 1 birdhouse  ½ Kite  Opportunity cost of 1 kite  2 birdhouses

Comparative Advantage  Thus Wendy has a comparative advantage of building birdhouses over kites.  For an hour of work she can make more birdhouses than kites  Todd does not have a comparative advantage for either product  One hour of work produces an equal number of products

Comparative Advantage  Things to remember: 1.Comparative advantage is an advantage in producing one product over another for ONE person or country. 2.It is NOT a comparison between people or countries. 3.This example assumes birdhouses and kites are worth the same amount.

Why Trade is Good  In a trade, both sides can benefit.  In a good trade, both sides end up better off than they were  Wendy has an absolute advantage over Todd in producing Kites and Birdhouses.  Given that Wendy is better at making both kites and birdhouses, why would she trade with Todd?

Why Trade is Good  Suppose Wendy and Todd agree to trade.  She will give him three birdhouses  And he will give her two kites

Why Trade is Good  For Todd two kites represent how much work?  1 hour  If Todd had spent that hour making birdhouses instead of kites how many birdhouses would he have?  2 birdhouses  Because of the trade, how many birdhouses does Todd have for that 1 hour of work?  3 birdhouses  Thus Todd is better off because of the trade

Why Trade is Good  For Wendy four birdhouses represent how much work?  ½ hour (30 minutes)  If Wendy had spent 30 minutes making kites instead of birdhouses how many kites would she have?  2 kites  Because of the trade, what does Wendy have for that ½ hour of work?  2 kites AND 1 birdhouse  Thus Wendy is better off because of the trade

Why Trade is Good  Notice how both people are better off.  Since Todd is worse at making both products, it makes sense that by trading with Wendy he is better off.  Even though Wendy is better at making both products, by trading with Todd she is better off too.  This is why international trade is good  This is also why all countries should produce those products that they have a comparative advantage over, even if they don’t have an absolute advantage over other countries

The U.S.  The U.S. is the world’s leading exporter  We export a wide range of goods and services  Germany and Japan are 2 nd and 3 rd  The U.S. is the world’s leading importer  $1.4 trillion dollars worth every year (17.3% of the world’s total)  Germany and Japan are 2 nd and 3 rd (but the U.S. imports more than both of them combined

Trade and Unemployment  Making sure we produce those goods that we have a Comparative Advantage in producing causes unemployment  Can you see why?  Because as technology and new inventions are created, the products we have a comparative advantage on change  Thus what we should be producing changes and this creates what types of unemployment?  Structural