Why do people – and nations – choose to be economically interdependent?

1. : • Why do people – and nations – choose to be economically interdependent? • How can trade make everyone better off? • What is absolute advantage? What is comparative advantage? How are these concepts similar? How are they different? 0

2. Interdependence Every day you rely on many people from around the world, most of whom you’ve never met, to provide you with the goods and services you enjoy. hair gel from Cleveland, OH cell phone from Taiwan dress shirt from China coffee from Kenya 0

3. Interdependence • One of the main principles in almost every intro text is :Trade can make everyone better off. • We now learn why people – and nations – choose to be interdependent, and how they can gain from trade. INTERDEPENDENCE AND THE GAINS FROM TRADE

4. The Production Possibilities Frontier The Production Possibilities Frontier (PPF): a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology 0 THINKING LIKE AN ECONOMIST

5. The PPF: What We Know So Far Points on the PPF possible efficient: all resources are fully utilized Points under the PPF possible not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF not possible THINKING LIKE AN ECONOMIST

6. The PPF and Opportunity Cost Recall: The opportunity cost of an item is what must be given up to obtain that item. • Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to the other. • Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. • The slope of the PPF tells you the opportunity cost of one good in terms of the other. THINKING LIKE AN ECONOMIST

7. The PPF and Opportunity Cost The slope of a line equals the “rise over the run,” the amount the line rises when you move to the right by one unit. slope = –1000 = –10 100 Here, the opportunity cost of a computer is 10 tons of wheat. THINKING LIKE AN ECONOMIST

8. A C T I V E L E A R N I N G 2PPF and Opportunity Cost In which country is the opportunity cost of cloth lower? FRANCE ENGLAND 7

9. Economic Growth and the PPF With additional resources or an improvement in technology, the economy can produce more computers, Economic growth shifts the PPF outward. more wheat, or any combination in between. THINKING LIKE AN ECONOMIST

10. Why the PPF Might Be Bow-Shaped Beer Mountain Bikes As the economy shifts resources from beer to mountain bikes: • PPF becomes steeper • opp. cost of mountain bikes increases THINKING LIKE AN ECONOMIST

11. Why the PPF Might Be Bow-Shaped At point A, most workers are producing beer, even those that are better suited to building bikes. So, do not have to give up much beer to get more bikes. At A, opp. cost of mtn bikes is low. A Beer Mountain Bikes THINKING LIKE AN ECONOMIST

12. Why the PPF Might Be Bow-Shaped At B, most workers are producing bikes. The few left in beer are the best brewers. Producing more bikes would require shifting some of the best brewers away from beer production, would cause a big drop in beer output. At B, opp. cost of mtn bikes is high. Beer B Mountain Bikes THINKING LIKE AN ECONOMIST

13. Why the PPF Might Be Bow-Shaped So, PPF is bow-shaped when different workers have different skills, different opportunity costs of producing one good in terms of the other. The PPF would also be bow-shaped when there is some other resource, or mix of resources with varying opportunity costs (E.g., different types of land suited for different uses). THINKING LIKE AN ECONOMIST

14. Our Example Two countries: the U.S. and Japan Two goods: computers and wheat One resource: labor 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 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

15. The U.S. PPF Wheat (tons) The U.S. has enough labor to produce 500 computers, 4,000 5,000 2,000 1,000 3,000 Computers 0 300 200 500 100 400 0 or 5000 tons of wheat, or any combination along the PPF. INTERDEPENDENCE AND THE GAINS FROM TRADE

16. The U.S. Without Trade Wheat (tons) 4,000 5,000 2,000 1,000 3,000 Computers 0 200 100 500 300 400 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. INTERDEPENDENCE AND THE GAINS FROM TRADE

17. 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. INTERDEPENDENCE AND THE GAINS FROM TRADE

18. 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. INTERDEPENDENCE AND THE GAINS FROM TRADE

19. 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. 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

20. Basic international trade terms 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. 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

21. 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: If each country has an absolute advantage in one good and specializes in that good, then both countries can gain from trade. 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

22. Two Measures of the Cost of a Good 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. 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

23. 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? 0 INTERDEPENDENCE AND THE GAINS FROM TRADE

24. Opportunity Cost and Comparative Advantage So, Japan has a comparative advantage in computers. Lesson: Absolute advantage is not necessary for comparative advantage! 0 INTERDEPENDENCE AND THE GAINS FROM TRADE