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Class 14 March 8 Last class: Results of Quiz 3 and problem set 1

Class 14 March 8 Last class: Results of Quiz 3 and problem set 1 2. Review of economic concepts and methods 3. International trade theory Today: 3. International trade theory Quiz 4 (Section 2.7) Next class: 3. International trade theory Reading:

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Class 14 March 8 Last class: Results of Quiz 3 and problem set 1

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  1. Class 14 March 8 Last class: Results of Quiz 3 and problem set 1 2. Review of economic concepts and methods 3. International trade theory Today: 3. International trade theory Quiz 4 (Section 2.7) Next class: 3. International trade theory Reading: 2. Review of economic concepts

  2. Class 14 • March 8 • Important date: • Problem set 2 due Thursday, March 22 • (Download the problem set from the class website)

  3. 3. International trade theory 3.1. Simple examples: two-person cases 3.2. Absolute and comparative advantages 3.3. Trade between two countries 3.4. The sources of comparative advantage 3.5. Other explanations for international trade 3.6. Measurement of the gains from trade 3.7. Exchange rate and its determination

  4. 3.1. Simple examples -- two-person cases Example 1: Suppose Kevin and Mark have just completed the data collection and analysis for a group project and are ready to write the project report that will include 18 pages of text and 10 graphs. Here are the estimated rates for both Kevin and Mark: Kevin Mark Text 2 pages/hr. 3 pages/hr. Graphs 2 graphs/hr. 1 graph/hr. 50/50 share with no specialization: Kevin: 9 pages of text and 5 graphs ==> 7 hrs Mark: 9 pages of text and 5 graphs ==> 8 hrs

  5. 3.1. Simple examples -- two-person cases With specialization: For example: Kevin: 8 graphs & 2 pages of text ==> 5 hrs Mark: 2 graphs & 16 pages of text ==> 7.3 hrs OR Kevin: 10 graphs and no text ==> 5 hrs Mark: 18 page of text and no graph ==> 6 hrs In this case, Kevin is more productive in graphs and Mark is more productive in text. When each person is more productive in one production, trade and specialization can benefit both of them.

  6. 3.1. Simple examples -- two-person cases Example 2: Suppose Ashley and Helen are another group for the same project (18 pages of text and 10 graphs) with the following estimated rates: Ashley Helen Text 2 pages/hr. 3 pages/hr. Graphs 1 graph/hr. 2 graphs/hr. 50/50 share with no specialization: Ashley: 9 pages of text & 5 graphs ==> 9.5 hrs Helen: 9 pages of text & 5 graphs ==> 5.5 hrs Helen is more productive in both text & graphs but Ashley is less productive in both text & graphs. Can specialization benefit both of them?

  7. 3.1. Simple examples -- two-person cases With specialization: Ashley: 14 pages of text & 2 graphs ==> 9 hrs Helen: 4 pages of text & 8 graphs ==> 5.33 hrs OR Ashley: 18 pages of text & no graph ==> 9 hrs Helen: 10 graphs and no text ==> 5 hrs Ashley is less productive in both text and graphs but is RELATIVELY more productive in preparing text (Helen is more productive in text & graphs and RELATIVELY more productive in graphs).

  8. 3.1. Simple examples -- two-person cases What can we conclude from the first two examples: (1) When each person is more productive in one activity, specialization and trade can benefit both of them (2) When each person is RELATIVELY more productive in one activity, specialization and trade can benefit both of them. What can we conclude from the third example (David and John) on the next page?

  9. 3.1. Simple examples -- two-person cases Example 3: David John Text 6 pages/hr. 3 pages/hr. Graphs 4 graphs/hr. 2 graphs/hr. 50/50 share with no specialization: David: 9 pages of text & 5 graphs ==> 2.75 hrs John: 9 pages of text & 5 graphs ==> 5.5 hrs David is more productive in both text & graphs and John is less productive in both text & graphs. Is John RELATIVELY more productive in text or graphs? For this example, we can not find a specialization that can benefit both David and John.

  10. 3.2. Absolute and comparative advantages: 3.2.1. Absolute advantage: -- One nation (person) is absolutely more productive than the other nation (person) in the production of one product in terms of that it can produce the same amount of output using less resources or it can produce more output using the same mount of resources. -- Definition on page 3-3 -- The two-person examples in Section 3.1

  11. 3.2. Absolute and comparative advantages: 3.2.2. Comparative advantage -- One nation (person) is relatively more productive than the other nation (person) in the production of one product when the product can be produced at lower cost in terms of the other goods. -- Definition on page 3-3 -- Two-person examples in Section 3.1.

  12. 3.2. Absolute and comparative advantages: 3.2.3. Theory of comparative advantage -- Absolute advantage is neither the “necessary” nor “sufficient” condition for trade -- Comparative advantage is the “necessary” and “sufficient” conditions for trade. -- Two-person examples in Section 3.1

  13. 3.2. Absolute and comparative advantages: 3.2.4. David Ricardo (1772-1823): -- A businessman, economist, policymaker, and one of the fathers of modern economics -- Major publication: Principles of Political Economy and Taxation, 1817 -- Major contribution: theory of comparative advantage -- History: -- In the early 19th century, British Parliament was controlled by landlords  “Corn Laws” limit grain imports and help exports  high price -- Industrial Revolution  needs to reduce grain prices -- Corn Laws were replaced in 1848 (25 yrs after Ricardo’s death)

  14. 3.3. Trade between two countries 3.3.1. Wheat and cotton production in Australia and New Zealand (Table 16.2 on p. 3-4) New Zealand Australia Wheat 6 bu./acre 2 bu./acre Cotton 2 bales/acre 6 bales/acre 3.3.2. Absolute advantage Australia: Cotton production New Zealand: Wheat production 3.3.3. Production with no trade (Table 16.3 on p. 3-4) -- How to interpret Figure 16.1 on p. 3-5? -- Production possibility frontier (PPF)

  15. 3.3. Trade between two countries 3.3.4. Gains from specialization and trade (Table 16.4) When both countries have absolute advantages, specialization and trade can benefit both nations A strong assumption here: 1 bushel of wheat can be exchanged for 1 bale of cotton How to interpret Figure 16.2 on p. 3-6?

  16. 3.3. Trade between two countries 3.3.5. Suppose the wheat and cotton productivity in Australia and New Zealand has changed to: New Zealand Australia Wheat 6 bu./acre 1 bu./acre Cotton 6 bales/acre 3 bales/acre 3.3.6. New Zealand has the absolute advantage in both wheat and cotton production (Australia does not have any absolute advantage) but Australia has the comparative advantage in cotton production (what comparative advantage does New Zealand have?) 3.3.7. Production with no trade (Table 16.6)

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