The Fundamentals of Trade Capitol Hill Campus May 21, 2010

1. The Fundamentals of Trade Capitol Hill Campus May 21, 2010 copies of this presentation can be found at www.antolin-davies.com

2. There are two countries. West East

3. In each country, there are 10 workers. West East

4. The workers make RED stuff and BLUE stuff. West East

5. The workers eat the RED stuff and BLUE stuff. West East

6. 1 2 6 Happiness = (RED stuff eaten) (BLUE stuff eaten)

7. Happiness = (RED stuff eaten) (BLUE stuff eaten) 0 0

8. West In West, a single worker can produce 2 RED stuff or 1 BLUE stuff or

9. In East, a single worker can produce 1 RED stuff or 2 BLUE stuff East or

10. You must decide how many workers to allocate to the production of RED stuff and how many to allocate to the production of BLUE stuff. Your goal is to attain the most happiness for your country.

11. Labor Allocation (must total 10) Production Imports (negative = exports) Production of Red Production of Blue Units of Red Units of Blue Units of Red Units of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed) Units of Red Units of Blue Example (using West): Suppose you choose to assign 2 Workers to RED production and 8 Workers to BLUE production or 4 8 2 8 4 8 32

12. Labor Allocation (must total 10) Production Imports (negative = exports) Production of Red Production of Blue Units of Red Units of Blue Units of Red Units of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed) Units of Red Units of Blue Example (using West): Suppose you choose to assign 3 Workers to RED production and 7 Workers to BLUE production or 6 7 3 7 6 7 42

13. Labor Allocation (must total 10) Production Imports (negative = exports) Production of Red Production of Blue Units of Red Units of Blue Units of Red Units of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed) Units of Red Units of Blue Example (using East): Suppose you choose to assign 3 Workers to RED production and 7 Workers to BLUE production or 3 14 3 7 3 14 42

14. Round 1: Autarky Allocate 10 workers to maximize your country’s happiness. or or

15. Round 1: Autarky

16. Now, you may produce, exchange, then consume. West East

17. Labor Allocation (must total 10) Production Imports (negative = exports) Production of Red Production of Blue Units of Red Units of Blue Units of Red Units of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed) Units of Red Units of Blue Example (using East): Suppose you choose to assign 3 Workers to RED production and 7 Workers to BLUE production. or 3 14 3 7 10 -8 Then, West agrees to trade you 10 RED in exchange for 8 BLUE. 13 6 78

18. Round 2: Trade Allocate 10 workers then trade (if you want) to maximize your country’s happiness. or or

19. Round 2: Trade

20. East has an absolute advantage in the production of BLUE stuff. • In West, 1 unit of BLUE costs 1 worker. • In East, 1 unit of BLUE costs 1/2 worker. • West has an absolute advantage in the production of RED stuff. • In West, 1 unit of RED costs 1/2 worker. • In East, 1 unit of RED costs 1 worker.

21. What if West is a lesser developed country such that East has an absolute advantage in the production of both RED and BLUE?

22. In West, a single worker can produce 2 RED stuff or 1 BLUE stuff West or

23. In East, a single worker can produce 3 RED stuff or 6 BLUE stuff East or

24. Round 3: Autarky (two worlds) Allocate 10 workers to maximize your country’s happiness. or or

25. Round 3: Autarky (two worlds)

26. East has an absolute advantage in the production of BLUE stuff. • In West, 1 unit of BLUE costs 1 worker. • In East, 1 unit of BLUE costs 1/6 worker. • East has an absolute advantage in the production of RED stuff. • In West, 1 unit of RED costs 1/2 worker. • In East, 1 unit of RED costs 1/3 worker.

27. Round 4: Trade (two worlds) Allocate 10 workers then trade (if you want) to maximize your country’s happiness. or or

28. Round 4: Trade (two worlds)

29. Round 4: Trade (two worlds)

30. Are we thinking about the problem correctly? When you choose to produce more RED stuff, what do you give up? When you choose to produce more BLUE stuff, what do you give up? • A country doesn’t give up workers when it produces stuff. • It gives up the other stuff it could be producing instead. • The opportunity cost of BLUE stuff isn’t a worker. • The opportunity cost of BLUE stuff is RED stuff!

31. or How many RED stuff does West have to give up to produce 1 more unit of BLUE stuff?  In West, the cost of 1 BLUE stuff is 2 RED stuff.

32. or How many RED stuff does West have to give up to produce 1 more unit of BLUE stuff?  In West, the cost of 1 BLUE stuff is 2 RED stuff. How many BLUE stuff does West have to give up to produce 1 more unit of RED stuff?  In West, the cost of 1 RED stuff is 1/2 of a BLUE stuff.

33. or How many RED stuff does East have to give up to produce 1 more unit of BLUE stuff?  In East, the cost of 1 BLUE stuff is 1/2 RED stuff.  In East, the cost of 1 RED stuff is 2 BLUE stuff.

34. West has a relative advantage in the production of RED stuff. • In West, 1 unit of RED costs ½ unit of BLUE. • In East, 1 unit of RED costs 2 units of BLUE. = = • East has a relative advantage in the production of BLUE stuff. • In West, 1 unit of BLUE costs 2 units of RED. • In East, 1 unit of BLUE costs ½ unit of RED. = =

35. What does RED stuff cost? • In West, 1 unit of RED equals ½ unit of BLUE. • In East, 1 unit of RED equals 2 units of BLUE. = = West will exportRED if West can get more than ½ BLUE. East will importRED if East can pay less than 2 BLUE.

36. What does BLUE stuff cost? • In West, 1 unit of BLUE equals 2 units of RED. • In East, 1 unit of BLUE equals ½ unit of BLUE. = = West will importBLUE if West can pay less than 2 RED. East will exportBLUE if East can get more than ½ RED.

37. Conclusions: • Trade is a positive sum relationship. • Exchanging goods and services is what’s important. Money is only a tool that facilitates the exchanging. • By definition, every country has a relative advantage in something. • 4. Trade is the combination of exchange and specialization. Specialization is the directing of resources toward a country’s relative advantage.

38. Why is trade controversial? Practical On the whole, societies are better off with trade though some individuals are not. Philosophical There are differences of opinion as to the nature of trade.

39. Protectionist Assumption: Trade leads to a centralization of political power, decreased competition, exploitation, and the concentration of wealth. Free Trade Assumption: Trade leads to a decentralization of political power, increased competition, empowerment, and the dissemination of wealth.

40. Income Protectionist argument: Trade results in increased income for one country at the expense of reduced income for the other country. Free Trade argument: Trade results in increased incomes for both trading partners.

41. Greater per-capita trade is associated with greater per-capita income. Source: International Financial Statistics, International Monetary Fund, December 2001

42. Income Distribution Protectionist argument: Trade results in an inequitable distribution of income. Free Trade argument: Trade is necessary for an equitable income distribution.

43. Countries that engage in more trade have more equitable income distributions. Source:International Financial Statistics, International Monetary Fund, December 2001, and Measuring Income Inequality: A New Database, Deininger, Klaus, and Lyn Squire, World Bank, 2002

44. Among the poorest countries, those that engage in more trade have more equitable income distributions. Lithuania Fiji Thailand Ukraine Source:International Financial Statistics, International Monetary Fund, December 2001, and Measuring Income Inequality: A New Database, Deininger, Klaus, and Lyn Squire, World Bank, 2002

45. Life Necessities Protectionist argument: Trade results in an exploitation of subsistence-level economies by technologically advanced economies. Free Trade argument: Trade benefits both technologically advanced and subsistence-level economies.

46. recommended Greater per-capita trade is associated with greater caloric intake. Source:International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002

47. Exploitation of the Powerless Protectionist argument: Trade results in the exploitation of the less powerful by the more powerful. Free Trade argument: Trade empowers the less powerful.

48. GDI measures quality of life (longevity, education, literacy, income) for women relative to men. Greater per-capita trade is associated with greater gender equality. Source:International Financial Statistics, International Monetary Fund, December 2001, and Human Development Report, United Nations Development Programme, 2002

49. Greater per-capita trade is associated with reduced child labor. Source: International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002

50. Even among middle-lower and lower income countries, greater per-capita trade is associated with reduced child labor. Source: International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002