|Home Page EC 340, International Trade and Finance Files EC 340 Lecture Notes Lecture 1: Why Do Nations Trade?||| Search|
In 1994, U.S. exports of goods were equal to 24% of the domestic output of goods. This is up from 8% in 1960 and 16% in 1980.
What change has occurred in the relation of goods imported to goods consumed?
In 1994, imports accounted for 28% of total goods consumed compared to just 7% in 1960.
But, trade between the United States and Japan is not like a sports contest, where one side wins and the other side loses. In fact, trade between countries can make each country better off.
Think about how trade affects your family. When a member of your family looks for a job, she competes against members of other families who are looking for jobs. Families also compete against each other when they are shopping because each family wants to buy the best goods at the lowest price. So, each family is competing with all the other families in the economy.
But, your family would not be better off isolating itself from all other families. If it did, your family would need to grow all of its own food, make its own clothes, and build its own house and car. Your family gains from its ability to trade with others. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods and services at a lower cost than if they tried to produce each good by themselves.
Countries also benefit from the ability to trade with one another. Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services. The Japanese are as much our partners in the world economy as they are our competitors.
However, is mowing his lawn the best use of Jordan's time? Suppose that in the same 2 hours it takes him to mow his lawn, he could film a Nike commercial and earn $10,000. Jordan's opporunity cost (the value of his next best alternative) of mowing the lawn is $10,000.
In contrast, Debbie's next best alternative is to wrap meat at Wegman's where she earns $8 an hour. So, in the 4 hours it would take her to mow Jordan's lawn, she could have earned $32. Debbie's opportunity cost of mowing his lawn is $32.
Jordan has an absolute advantage in mowing lawns because he can do the work in less time. But, Debbie has a comparative advantage in mowing lawns because she has the lower opportunity cost. A person or a country has a comparative advantage when they can produce a good at a lower opportunity cost compared to someone else.
The gains from trade are enormous. Rather than mowing his lawn, Jordan should make the commercial and hire Debbie to mow the lawn. As long as he pays her more than $32 and less than $10,000, both of them are better off.
Countries can benefit from specialization and trade with one another in the same way individuals can. The gains from trade do not disappear at national borders.
Ghana Peru wheat cloth wheat cloth (bushels) (bolts) (bushels) (bolts) 150 0 240 0 120 15 180 20 90 30 120 40 60 45 60 60 30 60 30 70 0 75 0 80
Ghana can get 15 more bolts of cloth by decreasing wheat production by 30 bushels. So, the price of 30 bushels of wheat in Ghana is 15 bolts of cloth. So, 1 bushel of wheat costs 1/2 bolt of cloth or 1 bolt of cloth costs 2 bushels of wheat.
In Peru, 1 bushel of wheat costs 1/3 bolt of cloth or 1 bolt of cloth costs 3 bushels of wheat.
Ghana can buy its wheat for only 1/3 bolt of cloth in Peru. Peru can buy one bolt of cloth in Ghana for just 2 bushels of wheat. So, there are gains from trade. These gains and the direction of trade are determined by comparative advantage.
Ghana has the comparative advantage in cloth production since its opportunity costs are smaller. Peru has the comparative advantage in wheat production. (Suppose there are 2 countries, A and B, and 2 goods, X and Y. If country A has a comparative advantage in good X, country B must have the comparative advantage in good Y.)
Ghana should specialize in cloth production and Peru in wheat production and then they trade. World production is 240 bushels of wheat and 75 bolts of cloth. No other combination will give so high a total world output.
Countries export the products that use their abundant factors intensively and import the products that use their scarce factors intensively.
A country is labor abundant if it has a higher ratio of labor to other factors of production than does the rest of the world.
A product is labor intensive if labor costs are a greater share of its value than they are of the value of other products.
Suppose 2 bushels of wheat = 1 bolt of cloth in the U.S. and 1 bushel of wheat = 1 bolt of cloth in the rest of the world. Wheat is relatively cheap in the U.S. H-O presumes that factor proportions account for comparative cost differentials.
So, the U.S. has relatively more of the factors that wheat uses intensively and relatively less of the factors that cloth uses intensively than does the rest of the world. Suppose land is the factor wheat uses intensively and labor is the factor cloth us es intensively. In other words, the U.S. must be land abundant.
U.S. land supply R.O.W. land supply ---------------- > ------------------ U.S. labor supply R.O.W. labor supplyimplications:
e.g. X = (2 slices of pizza, 3 bottles of beer) Y = (3 slices of pizza, 1 bottle of beer)Assume that the consumer can tell us whether
|Suppose she is indifferent between X and Y. Connecting the points gives an indifference curve. An indifference curve shows all combinations of pizza and beer that the consumer is indifferent among.|
Community indifference curves purport to show the preferences of the entire nation.
|Of all the points at which the country can produce, point E gives the highest utility. The line drawn through point E gives the equilibrium price ratio which brings producers and consumers into equilibrium.|
Producer surplus is the difference between the price firms would have been willing to accept and the price they actually receive. Graphically, producer surplus is the area above the supply curve below the market price.
Allowing more products and more countries makes the analysis more difficult but doesn't alter the basic gains from trade.
|David A. Latzko
Department of Business and Economics
Wilkes-Barre, PA 18766
phone: (717) 408-4718
fax: (717) 408-4917