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16.2 The Economic Basis for Trade

16.2 The Economic Basis for Trade. Why do nations trade? The distribution of resources is uneven. Efficient production requires different technologies or resource combinations. Products are differentiated as to quality and other non-price attributes. The Economic Basis for Trade.

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16.2 The Economic Basis for Trade

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  1. 16.2 The Economic Basis for Trade Why do nations trade? • The distribution of resources is uneven. • Efficient production requires different technologies or resource combinations. • Products are differentiated as to quality and other non-price attributes. Chapter 16, LO2

  2. The Economic Basis for Trade Labour-intensive goods Land-intensive goods Capital-intensive goods Chapter 16, LO2

  3. Specialization and Comparative Advantage The Basic Principle • Specialization according to comparative advantage reduces costs • This is true even if a nation has an absolute advantage Chapter 16, LO2

  4. Specialization and Comparative Advantage Two isolated nations (Canada and Brazil) • Constant Costs • straight-line production possibilities curves • Different Costs • different technology & resources • Canada has absolute advantage in both steel and soybeans Chapter 16, LO2

  5. 45 45 40 40 35 35 30 30 25 25 Soybeans (Tonnes) Soybean s(Tonnes) 20 20 15 15 10 10 5 5 0 0 5 10 15 20 25 30 5 10 15 20 Steel (Tonnes) Steel (Tonnes) Figure 16-3 Production Possibilities Curve (b) Brazil (a) Canada 12 A 4 Z 18 8 Chapter 16, LO2 20-5 LO2

  6. Specialization Based on Comparative Advantage • Self-sufficiency output mix • Specialization and trade • Produce the good with the lowest domestic opportunity cost • Opportunity cost of 1 tonnes of steel: • 1 tonnes of soybeans in Canada (1St = 1Soy). • 2 tonnes of soybeans in Brazil (1St = 2Soy) Chapter 16, LO2

  7. Table 16-3International Specialization According to Comparative Advantage and the Gains from Trade (in tonnes) Chapter 16, LO2

  8. Terms of Trade • What will the terms of trade be? • Canada 1St = 1Soy • Canada will sell 1St for more than 1Soy • Brazil 1St = 2Soy • Brazil will pay less than 2Soy for 1St • For trade to be mutually beneficial the terms of trade must be between each nation’s opportunity costs. • Settle between the two, depends on supply/demand factors (assume trade 1St for 1.5Soy). Chapter 16, LO2

  9. Gains from Trade • Gains from trade • Trading possibilities line • Slope equals terms of trade • Improved options • Complete specialization • More of both goods • More efficient resource allocation Chapter 16, LO2 20-9 LO2

  10. 45 45 40 40 35 35 30 30 25 25 Soybeans (Tonnes) Soybeans (Tonnes) 20 20 15 15 10 10 5 5 0 0 5 10 15 20 25 30 5 10 15 20 Steel (Tonnes) Steel (Tonnes) Figure 16-4 Trading Possibilities Lines and the Gains from Trade (a) Canada (b) Brazil V’ Trading Possibilities Line V Trading Possibilities Line v A’ 12 A Z’ 4 Z W B b b’ 8 18 Chapter 16, LO2 20-10 LO2

  11. Trade with Increasing Costs Concave production curve Resources not perfectly substitutable Incomplete specialization Chapter 16, LO2 20-11 LO2

  12. Case for Free Trade • Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well-being than without free trade. • Side benefits: • Promotion of competition, deterrence of monopoly • Linking of national interests, reduction of national animosities Chapter 16, LO2

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