CH 3 - Interdependence and the Gains from Trade PDF

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Instructor: Paul Lombardi...

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JAN 23, 25 CH 3 - Interdependence and the Gains from Trade Interdependence Most of us consume goods and services that are produced by other individuals in other countries Trade can make everyone better off Ex. US & Japan’s PPF

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Consumption w/o trade = using half its labor to produce each good

Exports - goods produced domestically and sold abroad Imports - goods produced abroad and sold domestically Where do these gains come from? Absolute advantage: the ability to produce a good using fewer resources than another producer (Measures the cost of a good in terms of the inputs required to produce it) (another measure of cost is opportunity cost) Ex^. the US has an absolute advantage in wheat (US: 10 labors hours vs. Japan: 25 labor hours) and computers (US: 100 labor hours vs. Japan: 125 labor hours) 2 countries can gain from trade when each specializes in the good it produces at lowest cost Comparative Advantage, Opportunity Cost, and Trade Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer (what the economy is giving up to produce product) Determines patterns of trade No economy has a comparative advantage in producing both goods Ex. US specializes in wheat so we automatically know that Japan will specialize in computers But, if the opportunity costs of producing both products are identical in both countries, there is no gain in trading, but it doesn’t mean they’ll be hurt by trading either Does not directly correspond w/the absolute advantage Ex^. US: 100 labor hours can produce 1 computer or 10 tons of wheat; Japan: 125 labor hours can produce 1 computer or 5 tons of wheat (aka. To produce 1 computer, Japan gives up less wheat) Japan has a comparative advantage in computers Gains from trade arise from comparative advantage (differences in opportunity cost) When each country specializes in the good(s) that it has a comparative advantage in, total production in all countries is higher → the world’s “economic pie” is bigger → all countries can gain from trade The same applies to individual producers who benefit by specializing in different goods and trading w/each other

Ex. Absolute and comparative advantage Argentina and Brazil each have 10,000 labor hours per month Absolute advantage in producing coffee? Brazil bc they only require 1 hr vs. Argentina requires 2 hrs

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1 lb of coffee

1 bottle of wine

Argentina

Requires 2 hrs

Requires 4 hrs

Brazil

Requires 1 hr

Requires 5 hrs

Comparative advantage in producing wine? Argentina, bc their opp. cost for producing wine is only 2 lbs of coffee 4 hrs required to produce 1 bottle of wine can produce 2 lbs of coffee) vs. Brazil’s opp. cost is 5 lbs of coffee 5 hrs required to produce 1 bottle of wine can produce 5 lbs of coffee) 1 lb of coffee

1 bottle of wine

Argentina

2 (4 hrs wine/2 hrs coffee)

½

Brazil

5/1 = 5 (5 hrs wine/1 hr coffee)

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Took the inverses

Q. Which of the following statements is not true about what we can observe from the Production Possibilities Frontier curve? a. The opportunity cost of producing the 2 goods b. Inefficient production bundles c. Bundles that can only be achieved if resources and/or technology increases d. How the country picked their production bundle Only shows what is produced, opportunity cost (slope), inefficient (below the curve), not feasible (above the curve) Q. If the PPF is a curved line, is the opportunity cost constant? No Q. Above the PPF line = shows a production bundle that an economy can never achieve, even in the future? No PPF only shows the current economy Q. Is there a case in our framework (ex. 2 goods, 2 countries, etc.) where 2 countries do not gain from trading? Yes When the comparative advantages of both economies are identical Patterns of trade is determined by the comparative advantage Comparative advantage does not say anything about ??...