DO NOW Why do people and countries trade as opposed to just making everything themselves?

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Presentation transcript:

DO NOW Why do people and countries trade as opposed to just making everything themselves?

Comparative and Absolute Advantage

Why do we trade? Absolute Advantage -1 firm is more efficient making a product than another. Ex: In 1 hour, Mr. Itokazu can make 5 computers. I can make 3. Ito has A.A. in Computers * What if 1 country had Abs. Advantage in everything?

Why do we trade? Comparative Advantage - when 1 country can make a product at a lower Opportunity Cost than another. *Countries Specialize in the good with the lowest Opportunity Cost! Think about this example……

Why do we trade? America and China both make Toys and Computers. -In 1 hour, America can make 10 toys. China can make 9. In 1 hour, America can make 10 computers. China can make 3.  Let’s draw both of their PPFs…

For Toys: USA can make more per hour = has ABSOLUTE advantage Units produced (Output) per hour Toys Computers America 10 China 9 3 For Toys: USA can make more per hour = has ABSOLUTE advantage For Computers: USA can make more per hour = has Abs. Adv.

Toys Computers America 10 China 9 3 For Comparative, we must calculate Opportunity Costs… Toys Computers America 1 (com) 1 (toy) China 1/3 (com) 3 (toys)

Toys Computers America 1 (com) 1 (toy) China 1/3 (com) 3 (toys) Firm have Comparative Adv. And will specialize in good with the LOWEST Opportunity Cost toys: 1/3<1 = China has CA Comps: 1<3 = USA has CA *None can have CA in Both!

Terms of Trade For trade to be helpful to BOTH, the terms of trade must be between the OC’s. Ex: OC for 1 toy for US is 1 comp. For China, 1/3 of a comp  Good if trade is 1 toy for 2/3 comp. (both consume beyond PPF)

Output vs. input can ask about output or input: Example of Output: “Units produced per hour” Example of input: “hours needed to produce one unit of…”  consider this…

Toys Computers America 10 China 9 3 Number of hours (Input) needed to produce one unit of… Toys Computers America 10 China 9 3 Toys: China more efficient=has A.A. Comp: China more efficient=has AA

Toys Computers America 10 China 9 3 Who has comparative advantage in Toys, Computers? find O.C.! Toys Computers America 1 China 3 1/3

Toys Computers America 1 China 3 1/3 Toys: 1<3  USA has C.A. Comps: 1/3 < 1  China has C.A.

Hours needed to make 1 (Input) Toys Computers America 10 China 9 3 Toys Computers America 1 China 9/3 3/9 Units produced per hour (Output) Toys Computers America 10 China 9 3 Toys Computers America 10/10 China 3/9 9/3

Shortcut!! Step 1: Determine if it’s an Output or Input question. Step 2: Figure which is more efficient = Absolute Advantage Step 3: Find O.C. Specialize in good w/ lowest OC. Step 4: Terms of trade b/w OC

Units produced per worker Cars Shirts Germany 6 12 Italy 2 10 Who has the Absolute advantage in Cars? Shirts? Who has Comparative adv. in each? What’s a good Trade Term?