International Trade Comparative and Absolute Advantage ©2012, TESCCC

International Trade International trade - voluntary exchange of goods and services between people of different nations ©2012, TESCCC

International Trade Trade helps a nation move beyond their Production Possibility Curve or Frontier GunsGuns Butter B C A F ©2012, TESCCC

3 Ways to Move Beyond PPF 1. Additional Resources 2. New Technology 3. International Trade ©2012, TESCCC

Billy bakes 10 cakes a day OR mows 5 lawns Brenda bakes 9 cakes a day OR mows 3 lawns Absolute Advantage: The ability to produce more of a given product with given resources than another country. Who has the absolute advantage in cake production? Who has the absolute advantage in lawn mowing production? ©2012, TESCCC

Billy bakes 10 cakes a day OR mows 5 lawns Brenda bakes 9 cakes a day OR mows 3 lawns Absolute Advantage: The ability to produce more of a given product with given resources than another country. Who has the absolute advantage in cake production? Billy - 10 is more than 9 Who has the absolute advantage in lawn mowing production? Billy - 5 is more than 3 ©2012, TESCCC

Billy bakes 10 cakes a day OR mows 5 lawns Brenda bakes 9 cakes a day OR mows 3 lawns ©2012, TESCCC

COMPARATIVE ADVANTAGE According to David Ricardo, whoever can make a product at the lowest opportunity cost should produce it. To determine who has the lower opportunity cost we need to get our ratio to show for every one item produced what will be given up or what could have been produced using those resources. Billy bakes 10 cakes a day OR mows 5 lawns Brenda bakes 9 cakes a day OR mows 3 lawns ©2012, TESCCC

Billy bakes 10 cakes a day OR mows 5 lawns Cakes Lawns Opportunity Cost ÷5 5÷5 2 1 To produce 1 lawn, it costs 2 cakes 2÷2 1÷2 1 1/2 To produce 1 cake, the opportunity cost is 1/2 a lawn ©2012, TESCCC

Brenda bakes 9 cakes a day OR mows 3 lawns Cakes Lawns 9 3 9÷3 3÷3 3 1 T o produce 1 lawn it costs 3 cakes 3÷3 1÷3 1 1/3 To produce 1 cake it costs 1/3 lawn ©2012, TESCCC

Who has the comparative advantage in cake production? Who has the comparative advantage in lawn production ? Billy Cakes Lawns /2 Brenda Cakes Lawns /3 ©2012, TESCCC

Who has the comparative advantage in cake production? Brenda because 1/3 is less than 1/2 Who has the comparative advantage in lawn production? Billy because 2 is less than 3 Billy Cakes Lawns /2 Brenda Cakes Lawns /3 ©2012, TESCCC

Terms of trade, or trading range 1 lawn mowing for 2-3 cakes If trade takes place in this range it will be beneficial to both parties. Billy Cakes Lawns /2 Brenda Cakes Lawns /3 ©2012, TESCCC

Advantages of trade based on comparative advantage: 1. All countries benefit - obtain more goods than if they produced everything on their own 2. Interdependence between countries is greater, countries no longer produce everything themselves 3. Standard of living increases for all ©2012, TESCCC

CAKESCAKES LAWNS PPF for Billy When Billy makes 1 more cake, he gives up 1/2 lawn. ©2012, TESCCC

CAKESCAKES LAWNS PPF for Billy When Billy mows 1 more lawn, he gives up 2 cakes. ©2012, TESCCC

CAKESCAKES LAWNS PPF for Brenda When Brenda bakes 1 more cake, she gives up 1/3 lawn. ©2012, TESCCC

CAKESCAKES LAWNS PPF for Brenda When Brenda mows 1 more lawn, she gives up 3 cakes. ©2012, TESCCC

International Trade Is based on Comparative advantage; countries specialize in what they can produce more cheaply Specialization leads to Economic efficiency leads to Less Self Sufficiency leads to Economic Interdependence Specialization allows more efficient use of our scarce resources. ©2012, TESCCC