Transcript Lecture15

More on trade issues
Today: Review of Test 1
Finishing comparative advantage
Introducing 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
Greg
David
Productivity Productivity in
in pizza
salad
production
production
20 / hour
10 / hour
16 / hour
4 / hour
However, we will see that each person has a
comparative advantage in producing one of the
goods
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
Greg
David

Opportunity cost Opportunity cost of
of cooking a pizza
making a salad
½ salad
2 pizzas
¼ salad
4 pizzas
Note that the two numbers in each row
are mathematical inverses of each other
Comparative advantage
Greg
David

Opportunity cost Opportunity cost of
of cooking a pizza
making a salad
½ salad
2 pizzas
¼ salad
4 pizzas
To find comparative advantage for each
person, find the lowest number in each
column
Comparative advantage
Greg
David


Opportunity cost Opportunity cost of
of cooking a pizza
making a salad
½ salad
2 pizzas
¼ salad
4 pizzas
David has comparative advantage in cooking pizzas
Greg has comparative advantage in making salads
Some things to note

Absolute advantage


The same person could have absolute
advantage in everything
Comparative advantage in a twoperson, 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