Chapter 3: Interdependence and the Gains from Trade. Ch. 3: Interdependence and the Gains from Trade

Transcription

1 Ch. 3: Interdependence and the Gains from Trade

2 Interdependence: every day you 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. Exports by country

3 Trade can make everyone better off. The United States and Canada both enjoy using computers and consuming maple syrup. The United States and Canada both have the ability to produce each. What does each country s production possibilities frontier (PPF) look like? What about if we allow trade?

4 What does the United States PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 The United States has 1, hours of labor per month and requires 5 hours to build a computer and 5 hours to tap a gallon of syrup. Gallons of maple 2 syrup 1 1 Number of computers 2

5 What does the United States PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 The United States has 1, hours of labor per month and requires 5 hours to build a computer and 5 hours to tap a gallon of syrup. Gallons of maple 2 syrup 1 1 Number of computers 2

6 What does the United States PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 The United States has 1, hours of labor per month and requires 5 hours to build a computer and 5 hours to tap a gallon of syrup. Gallons of maple 2 syrup 1 If the United States allocates half of its labor to computers and half of its labor to maple syrup, it will produce 1 computers and 1 gallons of maple syrup. 1 Number of computers 2

7 What does Canada s PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 Canada also has 1, hours of labor per month but requires 1 hours to build a computer and 2.5 hours to tap a gallon of syrup. Gallons of maple 2 syrup Number of computers 2

8 What does Canada s PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 Canada also has 1, hours of labor per month but requires 1 hours to build a computer and 2.5 hours to tap a gallon of syrup. Gallons of maple 2 syrup Number of computers 2

9 What does Canada s PPF look like? 4 United States monthly Production Possibilities Frontier (PPF) for maple syrup and computers 3 Gallons of maple 2 syrup If Canada allocates half of its labor to computers and half of its labor to maple syrup, it will produce 5 computers and 2 gallons of maple syrup. Canada also has 1, hours of labor per month but requires 1 hours to build a computer and 2.5 hours to tap a gallon of syrup Number of computers 2

10 Absolute and comparative advantage. Absolute advantage: the ability to produce a good using fewer inputs than another producer.

11 Absolute and comparative advantage. Absolute advantage: the ability to produce a good using fewer inputs than another producer. USA produces a computer using 5 hours of labor while Canada uses 1 hours to build a computer: USA has an absolute advantage over Canada in producing computer.

12 Absolute and comparative advantage. Absolute advantage: the ability to produce a good using fewer inputs than another producer. USA produces a computer using 5 hours of labor while Canada uses 1 hours to build a computer: USA has an absolute advantage over Canada in producing computer. Canada produces a gallon of maple syrup using 2.5 hours of labor while the USA uses 5 hours to produce a gallon of maple syrup: Canada has an absolute advantage over USA in producing maple syrup.

13 Absolute and comparative advantage. Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer.

14 Absolute and comparative advantage. Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer. USA: (i) opportunity cost of producing a computer is 1 gallons of maple syrup. (ii) opportunity cost of producing a gallon of maple syrup is.1 computers.

15 Absolute and comparative advantage. Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer. USA: (i) opportunity cost of producing a computer is 1 gallons of maple syrup. (ii) opportunity cost of producing a gallon of maple syrup is.1 computers. Canada: (i) opportunity cost of producing a computer is 4 gallons of maple syrup. (ii) opportunity cost of producing a gallon of maple syrup is.25 computers.

16 Absolute and comparative advantage. Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer. USA: (i) opportunity cost of producing a computer is 1 gallons of maple syrup. (ii) opportunity cost of producing a gallon of maple syrup is.1 computers. Canada: (i) opportunity cost of producing a computer is 4 gallons of maple syrup. (ii) opportunity cost of producing a gallon of maple syrup is.25 computers. Canada has a comparative advantage in producing maple syrup and the USA has a comparative advantage in producing computers.

17 Absolute and comparative advantage. In this example, the USA has both an absolute and comparative advantage in producing computers. In this example, Canada has both an absolute and comparative advantage in producing maple syrup. Opportunity cost of: 1 gallon of maple syrup 1 computer USA.1 computer 1 gallons of maple syrup Canada.25 computer 4 gallons of maple syrup

18 Trade allows for specialization: What does the USA-Canada production possibilities frontier look like if the USA specializes in computers, Canada specializes in maple syrup and they split the production among themselves?

19 4 Canada specializing with trade. United States-Canada production possibilities frontier (PPF) with trade 3 Canada produces 4 gallons of maple syrup when it specializes in its comparative advantage. USA produces 2 computers when it specializes in its comparative advantage. Gallons of maple 2 syrup Number of computers USA specializing with trade. 2

20 4 Canada specializing with trade. United States-Canada production possibilities frontier (PPF) with trade 3 Gallons of maple 2 syrup 1 Canada produces 4 gallons of maple syrup when it specializes in its comparative advantage. USA produces 2 computers when it specializes in its comparative advantage. After trading, both the USA and Canada receive 2 gallons of maple syrup and 1 computers. Notice this point is beyond the feasible production of either country (PPF lines) individually. 5 1 Number of computers USA specializing with trade. 2

21 4 USA and Canada PPF s (Alternative example: maple syrup and hockey sticks) The United States and Canada each have 1, hours of labor available per month. 3 Gallons of maple 2 syrup 1 A B D It takes the United States 2 hours to produce a hockey stick and ½ hour to produce a gallon of syrup. It takes Canada 3 minutes to make a hockey stick and 15 minutes to produce a gallon of syrup. Which line represents USA s PPF? Which line represents Canada s PPF? C 5 1 Hockey sticks 2

22 4 USA and Canada PPF s (Alternative example: maple syrup and hockey sticks) 3 Gallons of maple 2 syrup What country has an absolute advantage in producing hockey sticks? What country has an absolute advantage in producing maple syrup? What country has a comparative advantage in producing hockey sticks? What country has a comparative advantage in producing maple syrup? Hockey sticks 2

23 One country may have an absolute advantage over another country in all forms of production - but there is still a place for trade and specialization!

24 One country may have an absolute advantage over another country in all forms of production - but there is still a place for trade and specialization! Gains from trade arise from comparative advantage (differences in opportunity costs).

25 One country may have an absolute advantage over another country in all forms of production - but there is still a place for trade and specialization! Gains from trade arise from 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 economy pie is bigger, and all countries can gain from trade.

26 One country may have an absolute advantage over another country in all forms of production - but there is still a place for trade and specialization! Gains from trade arise from 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 economy pie is bigger, and all countries can gain from trade. The same applies to individual producers (like a farmer and a rancher) specializing in different goods and trading with each other.