More on trade issues

Today: Review of Test 1 Finishing comparative

advantageIntroducing international

trade

Who is this? Come to class to

find out We will find out

why he has made significant contributions to trade theory

Comparative advantage

We have done the basics of comparative advantage

Today We apply these principles, including

to international trade

Today

Comparative advantage and specialization

An introduction to trade Addressing concerns about trade

Example

Productivity in pizza

production

Productivity in salad production

Greg 20 pizzas cooked per

hour

10 salads made per hour

David 16 pizzas cooked per

hour

4 salads made per hour

Drop units to save space Notice that

Greg has absolute advantage in producing both pizzas and salads

However, we will see that each person has a comparative advantage in producing one of the goods

Productivity in pizza productio

n

Productivity in salad

production

Greg 20 / hour 10 / hour

David

16 / hour 4 / hour

Comparative advantage

Before we can determine comparative advantage, we must ask about each person “how much of ____ must I give up in order to produce an additional ____?” In other words, we need to determine

the opportunity cost of making one more pizza or one more salad for both Greg and David

Recall this table

Productivity in pizza

production

Productivity in salad production

Greg 20 pizzas cooked per

hour

10 salads made per hour

David 16 pizzas cooked per

hour

4 salads made per hour

Opportunity cost table

Note that the two numbers in each row are mathematical inverses of each other

Opportunity cost of cooking

a pizza

Opportunity cost of making a salad

Greg ½ salad 2 pizzas

David ¼ salad 4 pizzas

Comparative advantage

To find comparative advantage for each person, find the lowest number in each column

Opportunity cost of cooking

a pizza

Opportunity cost of making a salad

Greg ½ salad 2 pizzas

David ¼ salad 4 pizzas

Comparative advantage

David has comparative advantage in cooking pizzas

Greg has comparative advantage in making salads

Opportunity cost of cooking

a pizza

Opportunity cost of making a salad

Greg ½ salad 2 pizzas

David ¼ salad 4 pizzas

Some things to note

Absolute advantage The same person could have absolute

advantage in everything Comparative advantage in a two-

person, two-good economy Each person will almost always have

comparative advantage in exactly one of the two goods

From Greg and David to a big economy

To produce an efficient point in an economy, each good needs to be produced with lowest opportunity cost

All units in this graph in millions

From Greg and David to a big economy Notice that opportunity cost of pizzas

increases from A to C Opportunity cost increases as more is

produced

All units in this graph in millions

Changes in a production possibilities curve

Some factors that can shift a production possibilities curve Change in population War Investment in buildings, machines,

and other forms of capital Research and development in

technology

From comparative advantage to trade

Recall that Greg had comparative advantage at making salads, while David’s was making pizzas

Greg could make more salads than he wants to eat and trade them for pizzas from David Both can be made better off with

trade

International trade In the real world, trade is more complex

than simple two-good economies When trade becomes more open between

countries, there are typically millions of winners and often only thousands of losers Prices go down for goods on average The few displaced workers must find an

alternate form of work, typically at a lower wage

Addressing concerns about trade “A majority of Americans, including

60 percent of Republicans, now believe free trade is bad for the U.S. economy, according to recent NBC News-Wall Street Journal polls.”(Source: “Trade jitters, anti-China sentiment rouse US voters,” Reuters, Nov. 14, 2007)

Why do so many Americans have this opinion about trade?

Trade has costs and benefits

When another country can produce goods lower than in the United States, two things happen Jobs are lost in the United States Consumers pay lower prices for the good

that is now imported The news media usually focuses on

the jobs issue more than about prices

Why is media coverage skewed?

Any job lost seriously deteriorates the quality of life of an individual

Most people don’t care to read headlines advertising “The price of rice goes down by two cents per pound” However, small gains on many products

lead to substantial increases in the purchasing power of the dollar

Suppose there is protectionism elsewhere The United States is a leading exporter

of fresh fruit (see on-line reading list for source)

Suppose that other countries outlawed the import of fresh fruit US jobs lost Decrease in price of fruit in the US Increase in the price of fruit in other

countries

Protectionist policies

Suppose that protectionist policies were implemented Also suppose that these policies lead

to the price of goods on average increasing by 10 to 20 percent

Would you be in favor of this?

Another issue: Lead in toys Recently, many toys manufactured

in China have been recalled due to unsafe levels of lead

This has raised concerns about the viability of toy exports

China will stop exporting toys if the world does not view the toys as safe enough, given the price

Monitoring is costly

Monitoring toys for lead is costly, adding to the cost of toys purchased

However, testing costs may be small relative to the additional revenues that can be generated if the delivery of “safe toys” can be guaranteed

Another example: American cars Over the last 30 years, American cars

have often been looked at as “inferior” compared to some foreign models

With competition from trade, domestic car producers must keep costs down and quality up in order to successfully sell cars in the domestic market

The same thing goes for foreign toys If quality control standards are not

maintained abroad, people will buy their toys domestically

Trade issues There are many other issues that

are related to trade If you would like an in-depth

analysis of trade, you can enroll in a class that deals with trade

Wednesday, we will talk about the basic issues of trade, and who the winners and losers are

International trade We will examine more about international

trade in the next lecture Next lecture: More on the mathematical

analysis of international trade Look at lecture slides (no new reading)

Think about how trade benefits your everyday life Example: You could speculate about the price

of gas if OPEC countries stopped producing oil