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Interdependence and Gains From Trade: Assistant Professor

The document discusses how trade benefits countries through specialization based on comparative advantage. It uses an example of the US and Japan producing computers and wheat. Without trade, the US produces 250 computers and 2500 tons of wheat for itself, while Japan produces 120 computers and 600 tons of wheat. With trade, where each country specializes in its comparative advantage good, the US consumes 270 computers and 2700 tons of wheat, while Japan consumes 130 computers and 700 tons of wheat, demonstrating gains from trade. Specialization and trade allow both countries to consume more of both goods.

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86 views27 pages

Interdependence and Gains From Trade: Assistant Professor

The document discusses how trade benefits countries through specialization based on comparative advantage. It uses an example of the US and Japan producing computers and wheat. Without trade, the US produces 250 computers and 2500 tons of wheat for itself, while Japan produces 120 computers and 600 tons of wheat. With trade, where each country specializes in its comparative advantage good, the US consumes 270 computers and 2700 tons of wheat, while Japan consumes 130 computers and 700 tons of wheat, demonstrating gains from trade. Specialization and trade allow both countries to consume more of both goods.

Uploaded by

SH Raihan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Interdependence and

Gains from Trade 3

Abu Naser Mohammad Saif


Assistant Professor
Faculty of Business Studies
University of Dhaka
Cell: 01717686005
Interdependence
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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
3
Production Possibilities Frontier
The boundary between the
combinations of goods and services
that can be produced and the
combinations that cannot be produced,
given the available factors of
production and the state of technology.
The PPF is a valuable tool for
illustrating the effects of scarcity and its
consequences.
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.
The U.S. PPF
Wheat
(tons) The U.S. has enough labor
5,000 to produce 500 computers,
or 5000 tons of wheat,
4,000
or any combination along
3,000 the PPF.

2,000

1,000

Computers
0
100 200 300 400 500

6
The U.S. Without Trade
Wheat
(tons)
Suppose the U.S. uses half its labor
5,000
to produce each of the two goods.
4,000 Then it will produce and consume
250 computers and
3,000 2500 tons of wheat.

2,000

1,000

Computers
0
100 200 300 400 500

7
Japan’s PPF

Wheat
(tons)
Japan has enough labor to
produce 240 computers,
2,000 or 1200 tons of wheat,
or any combination
along the PPF.
1,000

0 Computers
100 200 300
8
Japan Without Trade

Wheat
(tons) Suppose Japan uses half its labor to
produce each good.
2,000 Then it will produce and consume
120 computers and
600 tons of wheat.
1,000

0 Computers
100 200 300
9
Consumption With and Without Trade
▪ Without trade,
▪ U.S. consumers get 250 computers
and 2500 tons wheat.
▪ Japanese consumers get 120 computers
and 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
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
Wheat
(tons)
5,000 Producing 3400 tons of wheat
requires 34,000 labor hours.
4,000
The remaining 16,000
3,000 labor hours are used to
produce 160 computers.
2,000

1,000

Computers
0
100 200 300 400 500

12
Japan’s Production With Trade

Wheat Producing 240 computers


(tons) requires all of Japan’s 30,000
labor hours.
2,000
So, Japan would produce
0 tons of wheat.

1,000

0 Computers
100 200 300
13
Exports & Imports
▪ 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.
ACTIVE LEARNING
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
Wheat
(tons) computers wheat
5,000 produced 160 3400
+ imported 110 0
4,000 – exported 0 700
= amount
3,000 270 2700
consumed
2,000

1,000

Computers
0
100 200 300 400 500

16
Japan’s Consumption With Trade

computers wheat
Wheat produced 240 0
(tons)
+ imported 0 700
2,000 – exported 110 0
= amount
130 700
consumed

1,000

0 Computers
100 200 300
17
Trade Makes Both Countries Better Off
U.S.
consumption consumption gains from
without trade with trade trade
computers 250 270 20
wheat 2500 2700 200
Japan
consumption consumption gains from
without trade with trade trade
computers 120 130 10
wheat 600 700 100
18
Where Do These Gains Come From?

▪ Absolute advantage: the ability to produce a


good using fewer inputs than another producer
▪ The U.S. has an absolute advantage in wheat:
producing a ton of wheat uses 10 labor hours
in the U.S. vs. 25 in Japan.
▪ If each country has an absolute advantage
in one good and specializes in that good,
then both countries can gain from trade.
Where Do These Gains Come From?

▪ Which country has an absolute


advantage in computers?
▪ Producing one computer requires
125 labor hours in Japan,
but only 100 in the U.S.
▪ The U.S. has an absolute
advantage.
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 the inputs required to produce it.
▪ Another measure of cost is opportunity cost.
▪ In our example, the opportunity cost of a
computer is the amount of wheat that could be
produced using the labor needed to produce one
computer.
Opportunity Cost and Comparative
Advantage

▪ Comparative advantage: the ability to


produce a good at a lower opportunity
cost than another producer
▪ Which country has the comparative
advantage in computers?
▪ To answer this, you must determine
the opportunity cost of a computer in
each country.
Opportunity Cost and
Comparative Advantage
▪ The opportunity cost of a computer is
▪ 10 tons of wheat in the U.S., because producing
one computer requires 100 labor hours,
which instead could produce 10 tons of wheat.
▪ 5 tons of wheat in Japan, because producing one
computer requires 125 labor hours,
which instead could produce 5 tons of wheat.

▪ So, Japan has a comparative advantage in


computers. Lesson: Absolute advantage is
not necessary for comparative advantage!
Comparative Advantage and Trade
▪ Gains from trade arise from
comparative advantage (differences in
opportunity costs).
▪ 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.
ACTIVE LEARNING
Absolute and comparative advantage
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?
ACTIVE LEARNING Answers
Brazil has an absolute advantage in coffee:
▪ Producing a pound of coffee requires only one
labor-hour in Brazil, but two in Argentina.
Argentina has a comparative advantage in wine:
▪ Argentina’s opp. cost of wine is two pounds of
coffee, because the four labor-hours required
to produce a bottle of wine could instead
produce two pounds of coffee.
▪ Brazil’s opp. cost of wine is five pounds of
coffee.
S U M M A RY
• Interdependence and trade allow everyone to
enjoy a greater quantity and variety of goods &
services.
• 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.
• When people or countries specialize in the
goods in which they have a comparative
advantage, the economic “pie” grows and trade
can make everyone better off.

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