1. ECON202, Maclachlan, Spring 20071 Interdependence & Gains from Trade Week 2

2. ECON202, Maclachlan, Spring 20072 Principle #5 Trade can make everyone better off.

3. ECON202, Maclachlan, Spring 20073 Alternative to Trade: Self Sufficiency

4. ECON202, Maclachlan, Spring 20074 Autarky A policy of national self-sufficiency and nonreliance on imports or economic aid.

5. ECON202, Maclachlan, Spring 20075 Mercantilism A country should aim to run trade surpluses and increase its monetary assets.

6. ECON202, Maclachlan, Spring 20076 Adam Smith (1723-1790) Critic of mercantilism. Countries should specialize and trade. Specialize where there’s an ABSOLUTE ADVANTAGE

7. ECON202, Maclachlan, Spring 20077 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.

8. ECON202, Maclachlan, Spring 20078 David Ricardo (1772-1823) Theory of comparative advantage. Even without an absolute advantage a region can trade to the benefit of all parties.

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

10. ECON202, Maclachlan, Spring 200710 Figure 1a The Production Possibilities Frontier

11. ECON202, Maclachlan, Spring 200711 Figure 1b The Production Possibilities Frontier

12. ECON202, Maclachlan, Spring 200712 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 … 32 - 15 = 17 oz of potatoes and 5 oz of meat. Farmer is better off.

13. ECON202, Maclachlan, Spring 200713 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.

14. ECON202, Maclachlan, Spring 200714 Figure 2a How Trade Expands the Set of Consumption Opportunities

15. ECON202, Maclachlan, Spring 200715 Figure 2b How Trade Expands the Set of Consumption Opportunities

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

17. ECON202, Maclachlan, Spring 200717 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.

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

19. ECON202, Maclachlan, Spring 200719 Country Example Two countries: the U.S. and Japan Two goods: computers and wheat One resource: labor, measured in hours

20. ECON202, Maclachlan, Spring 200720 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.

21. ECON202, Maclachlan, Spring 200721 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 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.

22. ECON202, Maclachlan, Spring 200722 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 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.

23. ECON202, Maclachlan, Spring 200723 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.

24. ECON202, Maclachlan, Spring 200724 Computers Wheat (tons) 2,000 1,000 200 0 100 300 Japan’s PPF Japan has enough labor to produce 240 computers, or 1200 tons of wheat, or any combination along the PPF.

25. ECON202, Maclachlan, Spring 200725 Japan Without Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 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.

26. ECON202, Maclachlan, Spring 200726 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.

27. ECON202, Maclachlan, Spring 200727 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

28. ECON202, Maclachlan, Spring 200728 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 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.

29. ECON202, Maclachlan, Spring 200729 Japan’s Production With Trade Producing 240 computers requires all of Japan’s 30,000 labor hours. Computers Wheat (tons) 2,000 1,000 200 0 100 300 So, Japan would produce 0 tons of wheat.

30. ECON202, Maclachlan, Spring 200730 International Trade Exports: goods produced domestically and sold abroad Imports: goods produced abroad and sold domestically

31. ECON202, Maclachlan, Spring 200731 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.)

32. ECON202, Maclachlan, Spring 200732 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 Computers Wheat (tons) U.S. Consumption With Trade computerswheat produced1603400 + imported1100 – exported0700 = amount consumed 2702700

33. ECON202, Maclachlan, Spring 200733 Japan’s Consumption With Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 computerswheat produced2400 + imported0700 – exported1100 = amount consumed 130700

34. ECON202, Maclachlan, Spring 200734 Trade Makes Both Countries Better Off U.S. consumption without trade consumption with trade gains from trade computers25027020 wheat2,5002,700200 Japan consumption without trade consumption with trade gains from trade computers12013010 wheat600700100