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1 ©2009 South-Western, a part of CengageLearning, all rights reserved C H A P T E R Interdependence and the Gains from Trade EconomicsP R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 3 In this chapter, look for the answers to these questions: § Why do people ?and nations ?choose to be economically interdependent? § How can trade make everyone better off? § What is absolute advantage? What is comparative advantage? How are these concepts similar? How are they different? 1 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. 2 INTERDEPENDENCE AND THE GAINS FROM TRADE 3 Interdependence § One of the Ten Principles from Chapter 1: Trade can make everyone better off. § We now learn why people ?and nations ? choose to be interdependent, and how they can gain from trade. INTERDEPENDENCE AND THE GAINS FROM TRADE 4 Our Example § Two countries: the U.S. and Japan § Two goods: computers and wheat § One resource: labor, measured in hours § We will look at how much of both goods each country produces and consumes §if the country chooses to be self-sufficient §if it trades with the other country INTERDEPENDENCE AND THE GAINS FROM TRADE 5 Production Possibilities in the U.S. § The U.S. has 50,000 hours of labor available for production, per month. § Producing one computer requires 100 hours of labor. § Producing one ton of wheat requires 10 hours of labor. 3 INTERDEPENDENCE AND THE GAINS FROM TRADE 6 4,000 100 5,000 2,000 1,000 3,000 500200 300 4000 Computers Wheat (tons) The U.S. PPF INTERDEPENDENCE AND THE GAINS FROM TRADE 7 4,000 100 5,000 2,000 1,000 3,000 500200 300 4000 Computers Wheat (tons) The U.S. Without Trade Suppose the U.S. uses half its labor to produce each of the two goods. Then it will produce and consume Use the following information to draw Japan?s PPF. § Japan has 30,000 hours of labor available for production, per month. § Producing one computer requires 125 hours of labor. § Producing one ton of wheat requires 25 hours of labor. Your graph should measure computers on the horizontal axis. A C T I V E L E A R N I N G 1 Derive Japan?s PPF 8 4 INTERDEPENDENCE AND THE GAINS FROM TRADE 9 Computers Wheat (tons) 2,000 1,000 200 0 100 300 Japan?s PPF INTERDEPENDENCE AND THE GAINS FROM TRADE 10 Japan Without Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 Suppose Japan uses half its labor to produce each good. Then it will produce and consume INTERDEPENDENCE AND THE GAINS FROM TRADE 11 Consumption With and Without Trade § Without trade, §U.S. consumers get ____ computers and _____ tons wheat. §Japanese consumers get ____ computers and ____ tons wheat. § We will compare consumption without trade to consumption with trade. § First, we need to see how much of each good is produced and traded by the two countries. 5 1. Suppose the U.S. produces 3400 tons of wheat. How many computers would the U.S. be able to produce with its remaining labor? Draw the point representing this combination of computers and wheat on the U.S. PPF. 2. Suppose Japan produces 240 computers. How many tons of wheat would Japan be able to produce with its remaining labor? Draw this point on Japan?s PPF. A C T I V E L E A R N I N G 2 Production under trade 12 INTERDEPENDENCE AND THE GAINS FROM TRADE 13 4,000 100 5,000 2,000 1,000 3,000 500200 300 4000 Computers Wheat (tons) U.S. Production With Trade INTERDEPENDENCE AND THE GAINS FROM TRADE 14 Japan?s Production With Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 6 INTERDEPENDENCE AND THE GAINS FROM TRADE 15 Basic International Trade Terms § Exports: goods produced domestically and sold abroad To export means to sell domestically produced goods abroad. § Imports: goods produced abroad and sold domestically To import means to purchase goods produced in other countries. A C T I V E L E A R N I N G 3 Consumption under trade 16 § How much of each good is consumed in the U.S.? Plot this combination on the U.S. PPF. § How much of each good is consumed in Japan? Plot this combination on Japan?s PPF. Suppose the U.S. exports 700 tons of wheat to Japan, and imports 110 computers from Japan. (So, Japan imports 700 tons wheat and exports 110 computers.) INTERDEPENDENCE AND THE GAINS FROM TRADE 17 4,000 100 5,000 2,000 1,000 3,000 500200 300 4000 Computers Wheat (tons) U.S. Consumption With Trade = amount consumed + imported ?exported 3400160produced wheatcomputers 7 INTERDEPENDENCE AND THE GAINS FROM TRADE 18 Japan?s Consumption With Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 = amount consumed + imported ?exported 0240produced wheatcomputers INTERDEPENDENCE AND THE GAINS FROM TRADE 19 Trade Makes Both Countries Better Off 2,500wheat 250computers gains from trade consumption with trade consumption without trade U.S. 600wheat 120computers gains from trade consumption with trade consumption without trade Japan INTERDEPENDENCE AND THE GAINS FROM TRADE 20 Where Do These Gains Come From? § Absolute advantage: § The U.S. has an absolute advantage in wheat: § If each country has an absolute advantage in one good and specializes in that good, then both countries can gain from trade. 8 INTERDEPENDENCE AND THE GAINS FROM TRADE 21 Where Do These Gains Come From? § Which country has an absolute advantage in computers? So why does Japan specialize in computers? Why do both countries gain from trade? INTERDEPENDENCE AND THE GAINS FROM TRADE 22 Two Measures of the Cost of a Good § Two countries can gain from trade when each specializes in the good it produces at lowest cost. § Absolute advantage measures the cost of a good in terms of § Recall: Another measure of cost is opportunity cost. § In our example, the opportunity cost of a computer is INTERDEPENDENCE AND THE GAINS FROM TRADE 23 Opportunity Cost and Comparative Advantage § Comparative advantage: § Which country has the comparative advantage in computers? § To answer this, must determine the opp. cost of a computer in each country. 9 INTERDEPENDENCE AND THE GAINS FROM TRADE 24 Opportunity Cost and Comparative Advantage § The opp. cost of a computer is §____ tons of wheat in the U.S., because §____ tons of wheat in Japan, because § So, _______________ has a comparative advantage in computers. Lesson: INTERDEPENDENCE AND THE GAINS FROM TRADE 25 Comparative Advantage and Trade § § 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, and all countries can gain from trade. § The same applies to individual producers (like the farmer and the rancher) specializing in different goods and trading with each other. Argentina and Brazil each have 10,000 hours of labor per month. In Argentina, §producing one pound coffee requires 2 hours §producing one bottle wine requires 4 hours In Brazil, §producing one pound coffee requires 1 hour §producing one bottle wine requires 5 hours Which country has an absolute advantage in the production of coffee? Which country has a comparative advantage in the production of wine? A C T I V E L E A R N I N G 4 Absolute & comparative advantage 26 10 A C T I V E L E A R N I N G 4 Answers 27 INTERDEPENDENCE AND THE GAINS FROM TRADE 28 Unanswered Questions?. § We made a lot of assumptions about the quantities of each good that each country produces, trades, and consumes, and the price at which the countries trade wheat for computers. § In the real world, these quantities and prices would be determined by § We will begin to study this in the next chapter. § For now, though, our goal was merely to see how trade can make everyone better off. roncron princ-ch03-studenthandout.ppt