Lecture Notes: Econ 203 Introductory Microeconomics
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Lecture Notes: Econ 203 Introductory Microeconomics Lecture/Chapter 3: Interdependence/gains from trade M. Cary Leahey Manhattan College Fall 2012. Goals. Why do people/nations choose to be interdependent How does trade make everyone better off Absolute versus comparative advantage

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Goals

Lecture Notes: Econ 203 Introductory MicroeconomicsLecture/Chapter 3: Interdependence/gains from tradeM. Cary LeaheyManhattan CollegeFall 2012


Goals
Goals

  • Why do people/nations choose to be interdependent

  • How does trade make everyone better off

  • Absolute versus comparative advantage

  • Definitions

  • Similarities/differences


Interdependence
Interdependence

  • One of 10 principles – trade makes everyone better off

  • Explain by example using the production possibilities frontier (PPF);

  • Simplifying assumptions:

  • Two nations

  • Two goods

  • One resource: labor which is more variable than capital


The u s ppf
The U.S. PPF

Wheat (tons)

The U.S. has enough labor to produce500 computers,

4,000

5,000

2,000

1,000

3,000

Computers

0

400

300

200

500

100

0

or 5000 tons of wheat,

or any combination along the PPF.

4


The u s without trade
The U.S. Without Trade

Wheat (tons)

4,000

5,000

2,000

1,000

3,000

Computers

0

300

200

500

100

400

0

Suppose the U.S. uses half its labor to produce each of the two goods.

Then it will produce and consume

250 computers and

2500 tons of wheat.

5


Japan s ppf
Japan’s PPF

Japan has enough labor to produce 240 computers,

Wheat (tons)

2,000

1,000

Computers

0

100

200

300

0

or 1200 tons of wheat,

or any combination along the PPF.

6


Japan without trade
Japan Without Trade

Wheat (tons)

2,000

1,000

Computers

0

100

200

300

0

Suppose Japan uses half its labor to produce each good.

Then it will produce and consume

120 computers and

600 tons of wheat.

7


Consumption with and without trade

0

Consumption With and Without Trade

  • Without trade,

    • U.S. consumers get 250 computers and 2500 tons wheat.

    • Japanese consumers get 120 computersand 600 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.


Production under trade
Production under trade

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.


U s production with trade
U.S. Production With Trade

Wheat (tons)

4,000

5,000

2,000

1,000

3,000

Computers

0

300

200

500

100

400

0

Producing 3400 tons of wheat requires 34,000 labor hours.

The remaining 16,000 labor hours are used to produce 160 computers.

10


Japan s production with trade
Japan’s Production With Trade

Wheat (tons)

2,000

1,000

Computers

0

100

200

300

0

Producing 240 computers requires all of Japan’s 30,000 labor hours.

So, Japan would produce 0 tons of wheat.

11


Consumption under trade
Consumption under trade

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.)

  • 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.


U s consumption with trade
U.S. Consumption With Trade

Wheat (tons)

computers

wheat

produced

160

3400

+ imported

110

0

– exported

0

700

= amount consumed

270

2700

1,000

5,000

3,000

2,000

4,000

Computers

0

100

400

300

200

500

0

13


Japan s consumption with trade
Japan’s Consumption With Trade

computers

wheat

Wheat (tons)

produced

240

0

+ imported

0

700

– exported

110

0

2,000

= amount consumed

130

700

1,000

Computers

0

100

200

300

0

14


Trade makes both countries better off
Trade Makes Both Countries Better Off

computers

250

270

20

wheat

2500

2700

200

Japan

consumption without trade

consumption with trade

gains from trade

computers

120

130

10

wheat

600

700

100

0

U.S.

consumption without trade

consumption with trade

gains from trade

15


Gains from trade
Gains from trade

  • What happens:

  • Trade separates consumption from production as consumption is above the PPF

  • Trade acts like technological progress, shifting up the PPF

  • Where do the gains come from?

  • Absolute advantage – the ability of one nation to produce a good with fewer resources

  • US has absolute advantage in wheat: 1 ton of what = 10 hours versus 25 in Japan

  • US has absolute advantage in computers: one computer = 100 hours in US versus 125 in Japan


Why do both countries gain from trade comparative advantage
Why do both countries gain from trade: comparative advantage

  • While Japan is worse in producing both goods it has a relative advantage in producing computers. The opportunity cost of producing computers is relatively lower

  • Opportunity cost of one computer

  • In US 10 tons of wheat

  • In Japan it is 5 tons of wheat


Summary
Summary

  • Interdependence allows everyone to be better off, breaking down the tie between domestic production and domestic consumption

  • Comparative advantage means being able to produce a good at a lower opportunity cost

  • Absolute advantage means being able to produce a good with fewer inputs.

  • Absolute advantage is not needed for comparative advantage.