Lecture’2’ Gains’from’Trade’ (Ch3)kmjungecn1.weebly.com/uploads/1/4/5/6/14568902/... ·...
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Lecture 2 Gains from Trade (Ch3)
Transcript of Lecture’2’ Gains’from’Trade’ (Ch3)kmjungecn1.weebly.com/uploads/1/4/5/6/14568902/... ·...
Lecture 2 Gains from Trade
(Ch3)
Interdependence
• One of the Micro Principles from Chapter 1: Trade can make everyone be/er off.
• We now learn why people—and naDons—choose to be interdependent, and how they can gain from trade.
One famous anecdote You social scienDsts suck!
Do you even have one theory that is true but non-‐trivial?
Stanislaw Ulam (1909-‐1984) Mathema7cian
(Several years!) later
“A theory of comparative advantage is logically true need not be argued before a mathematician; that is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them”
Paul Samuelson (1915-‐2009) Economist: A Farther of Modern Economics
Here’s the Example
• Two countries: the U.S. and China • Two goods: computers and apples
• One resource: labor, measured in hours
• We will look at how much of both goods each country produces and consumes – if the country chooses to be self-‐sufficient
– if it trades with the other country
ProducDon PossibiliDes in the U.S.
• The U.S. has 50,000 hours of labor available for producDon, per month.
• Producing one computer requires 100 hours of labor.
• Producing one apple requires 10 hours of labor.
4,000
100
5,000
2,000
1,000
3,000
500 200 300 400 0 Computers
Apples
The U.S. PPF The U.S. has enough labor to produce 500 computers, or 5000 apples, or any combination along the PPF.
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4,000
100
5,000
2,000
1,000
3,000
500 200 300 400 0 Computers
Apples
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 apples.
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ProducDon PossibiliDes in China
• China has 30,000 hours of labor available for producDon, per month.
• Producing one computer requires 125 hours of labor.
• Producing one apple requires 25 hours of labor.
Computers
Apples
2,000
1,000
200 0
100 300
China’s PPF
China has enough labor to produce 240 computers, or 1200 apples, or any combination along the PPF.
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China Without Trade
Computers
Apples
2,000
1,000
200 0
100 300
Suppose China uses half its labor to produce each good.
Then it will produce and consume 120 computers and 600 apples.
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ConsumpDon With and Without Trade
• Without trade,
– U.S. consumers get 250 computers and 2500 apples.
– Chinese consumers get 120 computers and 600 apples.
• Now, Paul says “Free trades can make both countries consume more in each item without the expansion of PPFs.”
• Stanislaw says “How come?”
Paul’s suggested mechanism
• IniDal producDon plan – U.S: {apples, computers}={3400, 160} – China: {apples, computers}={0, 240}
• InternaDonal price for a computer in units of apples: 7/1.1≈6.4
• So China trades 110 units of computers for 700 units of apples with U.S. according to his mechanism
4,000
100
5,000
2,000
1,000
3,000
500 200 300 400 0 Computers
Apples U.S. ProducDon With Trade
Producing 3400 apples requires 34,000 labor hours.
The remaining 16,000 labor hours are used to produce 160 computers.
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China’s ProducDon With Trade
Producing 240 computers requires all of China’s 30,000 labor hours.
Computers
Apples
2,000
1,000
200 0
100 300
So, China would produce 0 apple.
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4,000
100
5,000
2,000
1,000
3,000
500 200 300 400 0 Computers
Apples
U.S. ConsumpDon With Trade
2700 270 = amount consumed
0 110 + imported 700 0 – exported
3400 160 produced apples computers
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China’s ConsumpDon With Trade
Computers
Apples
2,000
1,000
200 0
100 300
700 130 = amount consumed
700 0 + imported 0 110 – exported
0 240 produced apples computers
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Trade Makes Both Countries Beeer Off
200 2700 2500 apples
20 270 250 computers
gains from trade
consumption with trade
consumption without trade
U.S.
100 700 600 apples
10 130 120 computers
gains from trade
consumption with trade
consumption without trade
China
Where Do These Gains Come From?
• Absolute advantage: the ability to produce a good using fewer inputs than another producer
• The U.S. has an absolute advantage in apples: producing an apple uses 10 labor hours in the U.S. vs. 25 in China.
• If each country has an absolute advantage in one good and specializes in that good, then both countries can gain from trade.
Where Do These Gains Come From?
• Which country has an absolute advantage in computers?
• Producing one computer requires 125 labor hours in China, but only 100 in the U.S.
• The U.S. has an absolute advantage in both goods!
So why does China specialize in computers? Why do both countries gain from trade?
Two Measures of the Cost of a Good
• Two countries can gain from trade when each specializes in the good it produces at lowest cost.
• Absolute advantage measures the cost of a good in terms of the inputs required to produce it.
• Recall: Another measure of cost is opportunity cost.
• In our example, the opportunity cost of a computer is the amount of apple that could be produced using the labor needed to produce one computer.
Opportunity Cost and ComparaDve Advantage
• Compara7ve advantage: the ability to produce a good at a lower opportunity cost than another producer
• Which country has the comparaDve advantage in computers?
• To answer this, must determine the opportunity cost of a computer in each country.
Opportunity Cost and ComparaDve Advantage
• The opportunity cost of a computer is – 10 apples in the U.S.: Producing one computer requires 100 labor hours, which instead could produce 10 apples.
– 5 apples in China: Producing one computer requires 125 labor hours, which instead could produce 5 apples.
• So, China has a comparaDve advantage in computers. Lesson: Absolute advantage is not necessary for compara9ve advantage!
ComparaDve Advantage and Trade
• Gains from trade arise from comparaDve advantage (differences in opportunity costs).
• When each country specializes in the good(s) in which it has a comparaDve advantage, total producDon in all countries is higher, the world’s “economic pie” is bigger, and all countries can gain from trade.
A C T I V E L E A R N I N G 1
Absolute and comparaDve advantage ArgenDna and Brazil each have 10,000 hours of labor per month.
In ArgenDna, – producing one pound coffee requires 2 hours – producing one boele wine requires 4 hours
In Brazil, – producing one pound coffee requires 1 hour – producing one boele wine requires 5 hours
Which country has an absolute advantage in the producDon of coffee? Which country has a comparaDve advantage in the producDon of wine?
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Unanswered QuesDons… • There are many different sets of quanDDes and prices for goods traded in internaDonal markets that could enlarge “economic pie”
• In the real world, these quanDDes and prices would be determined by the preferences of consumers and the technology and resources in both countries.
• We won’t pursue these complex issues here.
• For now, though, our goal was merely to see how trade can make everyone be/er off.
Summary
• Interdependence and trade allow everyone to enjoy a greater quanDty and variety of goods & services.
• ComparaDve advantage means being able to produce a good at a lower opportunity cost. Absolute advantage means being able to produce a good with fewer inputs.
• When people—or countries—specialize in the goods in which they have a comparaDve advantage, the economic “pie” grows and trade can make everyone beeer off.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
