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TOPIC 12Motivation for Trade
Tuesday, March 27, 12
BIG PICTURE
• How significant is world trade to the global economy?
• Why does trade occur and what are the theoretical benefits of trade?
• How can we motivate prices in international trade settings?
Tuesday, March 27, 12
Households
Output Market
Firms
FactorMarket
Consumption Expenditure
Revenue Costs
Income
Profits
EconomicInvestment
Government
TransfersTaxes
Government Expenditure
FinancialMarket
Loans
Repayment
Rest of the World
Save
Interest
LoansRepayment
Loans
RepaymentExports
Imports
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A VIEW OF TRADE
Artist: Eightfish; Cargo ships in Hong Kong harbor
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WHY TRADE?
• Can’t the US make everything?
• US relies on imports for bananas, cocoa, coffee, spices, tea, silk, nickel, tin, rubber, diamonds, luxury brands (Lexus?) ...
• US exports agricultural, computer, aircraft, coal, machine tool good
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WORLD’S TOP EXPORTERS
0
500
1,000
1,500
2,000
Belgi
umM
exico
Singa
pore
Russ
iaH
ong
Kong UK
Can
ada
Net
herla
nds
Italy
Sout
h Ko
rea
Fran
ceJap
an US
Ger
man
yC
hina EU
Valu
e Bi
llions
201
0 U
SD
Tuesday, March 27, 12
US TOP IMPORTERS / EXPORTERS
0
5
10
15
20
China
Canad
a
Mexico
Japan
Germany
4.36.3
12
14.5
19.1
Top exporters to US by % value
0
5
10
15
20
Canad
a
Mexico
China
Japan UK
Germany
3.83.84.7
7.2
12.8
19.5
Top importers from US by % value
% o
f $12
73 b
il U
S ex
port
s in
200
8
% o
f $19
10 b
il U
S im
port
s in
200
8
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HOW IMPORTANT IS TRADE TO GDP?
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VALUE PER CAPITA?
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ECONOMIC BASIS FOR TRADE
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• Think about an extreme example: An Apple engineer and a farmer
• The farmer can only grow food and the engineer only Apple computers
• Life is pretty bland (or short-lived) without the other, so the two might change
• Why might the two trade if both are capable of producing both food and Apple computers?
WHY BOTHER TRADING?
Tuesday, March 27, 12
REASONS FOR TRADE
• We will argue that with trade, both people are able to consume more than before
• Why?
1.Distribution of natural, human, and capital resources among countries is not uniform
2. Efficient production of various goods requires different technologies or allocations of resources
3.We may have preference for goods only available in other countries
• We can see some of these in an expansion of the production possibilities frontier
Tuesday, March 27, 12
SIMPLE RICARDIAN MODEL
• What if Brazil and the US only produce coffee and computers, and we look at explanations (1) and (2), that is there is some productivity and/or technology difference
• Time to create 1 computer or pound of coffee in the US and Brazil:
Computers Coffee
US 20 min / computer 10 min / pound
Brazil 1 hr / computer 15 min / pound
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PRODUCTION POSSIBILITIES
• Remember, the PPF describes the most we can produce with full use of resources (topic 4)
• If there are 8 hr / day, how much can be produced each day?
Computers Coffee
US 24 computers 48 pounds
Brazil 8 computers 32 pounds
Tuesday, March 27, 12
PRODUCTION POSSIBILITIES
• What is the country allocating?
• It could be labor, capital, let’s assume time
• So Brazil and the US have a stock of 8 hours; what are potential production options
• Precisely what we derived when we showed the max production of each good by country in 8 hours
Computers Coffee
US 24 computers 48 pounds
Brazil 8 computers 32 pounds
Tuesday, March 27, 12
PRODUCTION POSSIBILITIES
• We can illustrate these on a PPF since we have two points for each country
• The US can produce more of both goods in 8 hours, is there any reason to trade?
Computers
Coffee
48
24 Computers
Coffee
32
8
USA PPF Brazil PPF
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ABSOLUTE ADVANTAGE
• The fact that the US can produce more of both coffee and computers means it has an absolute advantage in both goods
• Absolute advantage: Able to produce more of a specific product than another country when it devotes all resources to producing it
• But, there can still be gains from trade
• In producing a computer, for example, the US (and Brazil) gives up some production of coffee because of limited time
• (The same is true for limited resources in a case with resource not time allocation)
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OPPORTUNITY COST
• Recall the price of one good in terms of what else is given up is opportunity cost (OC)
• We can figure out OC from the PPFs
• For the US, if we produce one more computer, how many coffees must we give up?
• It is simply the slope! So US OC(computers) = 2 coffee
• The (absolute value of) slope is the OC(good on x-axis) and the reciprocal is the OC(good on y-axis)
Computers
Coffee
48
24 Computers
Coffee
32
8
USA PPF Brazil PPF
Tuesday, March 27, 12
