MORE ON PRODUCTION MORE ON PRODUCTION POSSIBILITIES & POSSIBILITIES & SUPPLY/DEMANDSUPPLY/DEMAND

INTERNATIONAL TRADEINTERNATIONAL TRADE

Absolute versus Absolute versus Comparative Productivity Comparative Productivity

AdvantageAdvantage Absolute productivity advantage: held by Absolute productivity advantage: held by

a country that produces more of a certain a country that produces more of a certain good per hour worked than anothergood per hour worked than another

Comparative productivity advantage (or Comparative productivity advantage (or comparative advantage): held by a comparative advantage): held by a country that has lower opportunity costs country that has lower opportunity costs of producing a good than its trading of producing a good than its trading partners do partners do

Comparative advantage allows a country Comparative advantage allows a country that lacks absolute advantage to sell its that lacks absolute advantage to sell its products abroadproducts abroad

Output per Hour WorkedOutput per Hour Worked

Product Output per hour worked

Cars 2 0.5

Steel 3 tons 1 ton

Japan has an absolute advantage in both cars (2>0.5) and steel (3>1), yet it can still gain from trade, as can MexicoOnce trade opens, the world price of cars will be between one and three tons of steel per car

Pwc = world price1(tons/car) < Pwc< 2(tons/car)

Market for cars faced by Market for cars faced by Japanese producersJapanese producers

Demand for cars

Supply of cars

World price of carsPrice of cars

Quantity of cars

The world price of cars is higher than the equilibrium price in Japan--- Japan will export cars

Market for cars faced by Market for cars faced by Mexican producersMexican producers

Demand for cars

Supply of cars

World price of cars

Price of cars

Quantity of cars

The world price of cars is lower than the equilibrium price in Mexico--- Mexico will import cars to augment their supply

Imports

Domestic supply

Comparative versus Comparative versus Competitive AdvantageCompetitive Advantage

Comparative advantage = competitive (commercial) advantage when the prices of both inputs and outputs are an accurate indication of their relative scarcity

Comparative advantage competitive advantage when the markets fail to correctly value the price of inputs and outputs • Imbalances result from government policies,

such as subsidies or protection

Restructuring may occur in an economy Restructuring may occur in an economy – or policy may be imposed that – or policy may be imposed that restructures the economyrestructures the economy

Some industries or sectors then may Some industries or sectors then may grow, but others may not grow or vanishgrow, but others may not grow or vanish• In the Ricardian model, trade opening moved labor In the Ricardian model, trade opening moved labor

from bread to steel productionfrom bread to steel production• restructuring improved U.S. overall economic welfare restructuring improved U.S. overall economic welfare

but made its bread industry diminish some but made its bread industry diminish some

• If trade results in net gain (in an increase of If trade results in net gain (in an increase of the consumption bundle), a country will be the consumption bundle), a country will be better off by trading; however, some sectors better off by trading; however, some sectors may still losemay still lose

Impacts of ComparativeImpacts of ComparativeAdvantageAdvantage

Comparative advantage allows gains Comparative advantage allows gains from trade to occurfrom trade to occur

However, when a nation moves along its However, when a nation moves along its PPC toward a new mix of industries to PPC toward a new mix of industries to exploit its comparative advantage, the exploit its comparative advantage, the transition period may hurt some – some transition period may hurt some – some nations initiate mobility training and nations initiate mobility training and transition policiestransition policies

Economic restructuring caused by trade opening produces higher living standards; however, in the short-term, restructuring is often costly

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PRODUCTION POSSIBILITIES IN THE U.S. AND BRAZIL PRODUCTION POSSIBILITIES IN THE U.S. AND BRAZIL IN PRODUCING WHEAT AND SUGAR --- INCREASING IN PRODUCING WHEAT AND SUGAR --- INCREASING

COST CASECOST CASE

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BRAZILBRAZILUSAUSA

BRAZIL AND THE U.S. BOTH PRODUCE WHEAT AND SUGAR –

BRAZIL IS MORE PRODUCTIVE IN PRODUCING WHAT?

THE U.S. IS MORE PRODUCTIVE IN PRODUCING WHAT?

TERMS OF TRADETERMS OF TRADE

PRODUCTION POSSIBILITIES CURVE

PRODUCTION POSSIBILITIES CURVE

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BRAZILBRAZILUSAUSA

NOW PLACE THE COMMUNITY INDIFFERENCE CURVES (CIC) FOR THE U.S. AND BRAZIL

THE TANGENCY OF THE CIC CURVES WITH BOTH THE TERMS OF TRADE AND THE PPC GIVES THE EQUILIBRIUM AMOUNT OF WHEAT AND SUGAR TO BE PRODUCED AND CONSUMED IN EACH NATION WITHOUT TRADE BETWEEN NATIONS (A LEVEL OF a OF WHEAT AND A LEVEL OF b OF SUGAR IN THE U.S. AND A LEVEL OF c OF WHEAT AND A LEVEL OF d OF SUGAR IN BRAZIL

a

b

c

d

Trade conditionsTrade conditions

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NOW ALLOW TRADE TO OCCUR BETWEEN BRAZIL AND THE U.S. ---- THE TERMS NOW ALLOW TRADE TO OCCUR BETWEEN BRAZIL AND THE U.S. ---- THE TERMS OF TRADE CHANGES AS SHOWN (THE DOUBLE LINE REFLECTS OF TRADE CHANGES AS SHOWN (THE DOUBLE LINE REFLECTS PRODUCTION,WHILE THE SOLID LINE REFLECTS CONSUMPTION)PRODUCTION,WHILE THE SOLID LINE REFLECTS CONSUMPTION)

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WITH TRADE, THE TERMS OF TRADE CHANGES SLIGHTLY --- EACH NATION MOVES OUT ONTO A HIGHER CIC (THE DASHED CIC’s) ---- PRODUCTION BECOMES THE DOUBLE LINE IN EACH NATION CASE ---- IN BRAZIL, PRODUCTION OF SUGAR INCREASES AND PRODUCTION OF WHEAT DECREASES --- IN THE U.S., WHEAT PRODUCTION INCREASES CONSIDERABLY AND SUGAR PRODUCTION IS DECREASED CONSIDERABLY

IN BRAZIL, WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES SLIGHTLY

IN THE U.S., WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES

TRADE INDUCES CHANGES IN PRODUCTION AND TRADE INDUCES CHANGES IN PRODUCTION AND CONSUMPTION GIVEN THE TECHNOLOGY(PPC) CONSUMPTION GIVEN THE TECHNOLOGY(PPC)

AND THE PREFERENCES EXPRESSED IN THE CICAND THE PREFERENCES EXPRESSED IN THE CIC

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UNDER TRADE CONDITIONS, BOTH BRAZIL AND THE U.S. ARE NOT LIMITED BY UNDER TRADE CONDITIONS, BOTH BRAZIL AND THE U.S. ARE NOT LIMITED BY THEIR PRODUCTION TECHNOLOGIES -- TRADE ALLOWS BOTH NATIONS TO THEIR PRODUCTION TECHNOLOGIES -- TRADE ALLOWS BOTH NATIONS TO INCREASE ECONOMIC WELFARE BY MOVING OUT TO A HIGHER CICINCREASE ECONOMIC WELFARE BY MOVING OUT TO A HIGHER CIC

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BRAZILBRAZILUSAUSA

WITH TRADE, THE TERMS OF TRADE CHANGES SLIGHTLY --- EACH NATION MOVES OUT ONTO A HIGHER CIC (THE DASHED CIC’s) ---- PRODUCTION BECOMES THE DOUBLE LINE IN EACH NATION CASE ---- IN BRAZIL, PRODUCTION OF SUGAR INCREASES AND PRODUCTION OF WHEAT DECREASES --- IN THE U.S., WHEAT PRODUCTION INCREASES CONSIDERABLY AND SUGAR PRODUCTION IS DECREASED CONSIDERABLY

IN BRAZIL, WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES SLIGHTLY

IN THE U.S., WHEAT CONSUMPTION INCREASES AND SUGAR CONSUMPTION DECREASES