Principles of Macroeconomics Notes: Trade and Comparative Advantage

"Trade with China makes most Americans better off because, among other advantages, they can buy goods that are made or assembled more cheaply in China."

Economists agree with this statement.

Interdependence: Rely on many people from around the world, most of whom you've never met, to provide you with the goods and services you enjoy.

"Trade can make everyone better off"

One of the Ten Principles from Chapter 1

LABOR HOUR EXAMPLES:

The U.S. economy has 50,000 labor hours per month available for production

  • Produces only two goods: airplanes and soybeans
  • To produce 1 airplane requires 500 labor hours
  • To produce 1 ton of soybeans requires 10 labor hours

The U.S. has enough labor to produce

  • 100 airplanes
  • OR 5,000 tons of soybeans
  • OR any combination along the PPF

Japan has 30,000 labor hours per month available for production

  • Produces only two goods: airplanes and soybeans
  • To produce 1 airplane requires 625 labor hours
  • To produce 1 ton of soybeans requires 25 labor hours

Japan has enough labor to produce:

  • 48 airplanes
  • OR 1,200 tons of soybeans
  • OR any combination along the PPF.

U.S. produces 3,500 tons of soybeans. How many airplanes can the U.S. produce with the remaining resources? Draw this point on the PPF.

Producing 3,500 tons of soybeans requires 3,500 * 10 = 35,000 labor hours.

  • The remaining (50,000 - 35,000) = 15,000 labor hours are used to produce 15,000 / 500 = ==30 airplanes.==

Japan produces 48 airplanes. How many tons of soybeans can Japan produce with the remaining resources? Draw this point on the PPF.

Producing 48 airplanes requires all of Japan's resources: 48 * 625 = 30,000 labor hours.

  • So, Japan would produce ==0 tons of soybeans.==

IMPORTS AND EXPORTS

  • Imports: Goods produced abroad and sold domestically
  • Exports: Goods produced domestically and sold abroad

The U.S. exports 880 tons of soybeans and imports 22 airplanes. How much of each good is consumed in the U.S.? Plot this combination on the U.S. PPF.

  • 52 airplanes, 2620 soybeans

Japan exports 22 airplanes and imports 880 tons of soybeans. How much of each good is consumed in Japan? Plot this combination on Japan's PPF.

  • 26 airplanes, 880 soybeans

ABSOLUTE AND COMPARATIVE ADVANTAGE

Absolute advantage: The ability to produce a good using fewer inputs than another producer, measures the cost of a good in terms of the inputs required to produce it

  • Two countries can gain from trade when each specializes in the good it produces at the lowest cost.

Comparative advantage: The ability to produce a good at a lower opportunity cost than another producer

Principle of comparative advantage: Each good should be produced by the individual that has the smaller opportunity cost of producing that good.

  • Gains from trade arise from a comparative advantage (differences in opportunity costs)

When each country specializes in the good(s) in which it has a comparative advantage

  • Total production in all countries is higher
  • The world's "economic pie" is bigger
  • All countries can gain from trade

The price of trade must lie between their opportunity costs.

"Some Americans who work in the production of competing goods, such as clothing and furniture, are made worse off by trade with China."

96% economists agree, 4% uncertain

Trade makes everyone better off.

  • It allows people to specialize in those activities in which they have a comparative advantage

Which of the following is not true when each country specializes in the good(s) in which it has a comparative advantage?

a. All countries can gain from trade

b. The world economy is larger (bigger economic pie)

c. Total production for all countries is higher

d. Political conflict is avoided

==d. (Political conflict is independent of trade most of the time.)==

Assume that Germany can produce 1,000 automobiles using 10 hours of labor and Scotland can produce 1,000 automobiles using 15 hours of labor. What is true?

  • ==Germany has the absolute advantage==

DESERTED ISLAND EXAMPLE

Assume George and Abe are stranded on an island and can only produce two goods: fish and coconuts.

  • George can catch 20 fish or collect 5 coconuts in one day
  • Abe can catch 15 fish or collect 3 coconuts in one day.

What is George's opportunity cost of catching 1 fish?

  • ==1/4 of a coconut==

Assume George and Abe are stranded on an island and can only produce two goods: fish and coconuts.

  • George can catch 20 fish or collect 5 coconuts in one day
  • Abe can catch 15 fish or collect 3 coconuts in one day.

What is Abe's opportunity cost of catching 1 fish?

  • ==1/5 of a coconut==

Assume George and Abe are stranded on an island and can only produce two goods: fish and coconuts.

  • George can catch 20 fish or collect 5 coconuts in one day
  • Abe can catch 15 fish or collect 3 coconuts in one day.

Should George or Abe specialize in catching fish?

  • ==Abe==