Specialisation and trade and pattern of trade Topic 9: aggregate demand and aggregate supply Specialisation and trade and pattern of trade

4.1.2 Specialisation and trade, 4.1.3 pattern of trade Students should be able to: Analyse factors influencing the pattern of trade between countries and changes in trade flows between countries (comparative advantage, impact of emerging economies, growth of trading blocs and bilateral trading agreements and changes in relative exchange rates) Define absolute and comparative advantage (numerically and diagrammatically) Analyse the assumptions and limitations relating to the theory of comparative advantage Evaluate the advantages and disadvantages of specialisation and trade in an international context

Why does international trade occur? Microeconomics Topic 1: The Economic Problem Why does international trade occur?

What factors influence the pattern of trade? Microeconomics Topic 1: The Economic Problem C_________________ advantage (see later) Impact of emerging economies: countries tend to grow and thus tend to ________ more; hence they need to _______ more to pay for this Growth of trading ________ and bilateral trading agreements (see 4.1.5) Changes in relative exchange ________ (see 4.1.8) blocs, comparative, export, import, rates

Microeconomics Topic 1: The Economic Problem Shares of World Economic output in 2015: Brazil, China, France, Germany, India, Japan, Russia, UK, USA

Microeconomics Topic 1: The Economic Problem Absolute advantage Microeconomics Topic 1: The Economic Problem ______________: pin factory and specialisation What is specialisation? Absolute advantage exists when a country is able to produce a good more _____________ in absolute terms than another country

Absolute advantage example Microeconomics Topic 1: The Economic Problem Absolute advantage example Cost per unit in worker hours Wheat Wine England 10 15 Portugal 20 Assume there are only two countries producing only two goods and labour is the only cost. Which has an absolute advantage in wine? Which has an absolute advantage in wheat? What would benefit both countries?

Comparative advantage Microeconomics Topic 1: The Economic Problem David Ricardo – countries are better off trading even if they can produce all goods more cheaply Comparative advantage exists when a country is able to produce a good more cheaply relative to other goods produced domestically than another country Theory of comparative advantage: countries will find it mutually advantageous to trade if the opportunity cost of production differs

Comparative advantage example Microeconomics Topic 1: The Economic Problem Comparative advantage example Cost per unit in worker hours Wheat Wine England 15 30 Portugal 10 How many hours? One unit of wine in England takes ____ worker hours to produce One unit of wheat in England takes ___ hours One unit of wine in Portugal takes ____ hours One unit of wheat in Portugal takes ___ hours

Comparative advantage example Microeconomics Topic 1: The Economic Problem Comparative advantage example Cost per unit in worker hours Wheat Wine England 15 30 Portugal 10 Portugal has an absolute advantage in both Wine in England costs twice as much to produce as wheat. Wine in Portugal costs ____ times as much to produce as wheat. Portugal has a comparative advantage in _____ It would benefit both countries if they traded and England produced ________, Portugal _______

Exam marks: opportunity cost calculations Microeconomics Topic 1: The Economic Problem Cost per unit in worker hours Wheat Wine England 15 30 Portugal 10 Opportunity cost of 1 unit wheat Opportunity cost of 1 unit wine England Portugal

How do I calculate opportunity cost for England? Microeconomics Topic 1: The Economic Problem How do I calculate opportunity cost for England? Cost per unit in worker hours Wheat Wine England 15 30 England takes ___ hours to produce 1 unit wheat and ___ hours to produce 1 unit wine After 15 hours it has produced 1 unit wheat or 0.5 unit wine So opportunity cost of 1 unit wheat is 0.5 wine After 30 hours it has made __ wine or __ wheat So opportunity cost of 1 wine is ___ wheat

How do I calculate opportunity cost for Portugal? Microeconomics Topic 1: The Economic Problem How do I calculate opportunity cost for Portugal? Cost per unit in worker hours Wheat Wine Portugal 10 15 Portugal takes ___ hours to produce 1 unit wheat and ___ hours to produce 1 unit wine After 10 hours it has produced ___ unit wheat or ________ unit wine So opportunity cost of 1 unit wheat is ______ wine Also after 15 hours it has made __ wine or ____ wheat So opportunity cost of 1 unit wine is _____ wheat

Exam marks: opportunity cost calculations Microeconomics Topic 1: The Economic Problem Exam marks: opportunity cost calculations Cost per unit in worker hours Wheat Wine England 15 30 Portugal 10 Opportunity cost of 1 unit wheat Opportunity cost of 1 unit wine England Portugal England has a lower opportunity cost than Portugal for _______ so England should produce ______ Portugal has a lower opportunity cost than England for ______ so Portugal should produce ______

Comparative advantage example continued Microeconomics Topic 1: The Economic Problem Comparative advantage example continued Cost per unit in worker hours Wheat Wine England 15 30 Portugal 10 Assume England and Portugal have 300 workers each and before they traded England produced 4 units of wheat, Portugal 15. Complete the table Before trade After trade Wheat Wine England 4 Portugal 15 Total 19

Calculations for England before trade Microeconomics Topic 1: The Economic Problem England has 300 worker hours. 1 unit wheat takes 15 hours and England produced 4 units of wheat, this takes _____________ hours Therefore England has ______ hours = ____ hours to make wine Wine takes 30 hours to make __________ hence England makes ___ units wine

Calculations for Portugal before trade Microeconomics Topic 1: The Economic Problem Portugal has 300 worker hours. 1 unit wheat takes ___ hours and Portugal produced ____ units of wheat, this takes ___ hours Therefore Portugal has _________ hours to make wine Wine takes 15 hours to make hence Portugal makes _____ units wine

Calculations for England after trade Microeconomics Topic 1: The Economic Problem England has 300 worker hours and it has a comparative advantage in wheat so it will only make wheat 1 unit wheat takes 15 hours to make 300/15 = _____ units wheat

Calculations for Portugal after trade Microeconomics Topic 1: The Economic Problem Portugal has 300 worker hours and it has a comparative advantage in wine so it will only make wine 1 unit wine takes 15 hours to make __ units wine

Comparative advantage answers Microeconomics Topic 1: The Economic Problem Comparative advantage answers Before trade After trade Wheat Wine England Portugal Total Before trade total production was ___ wheat and ___ wine (___ units in total) After trade total production was __ wheat and ___wine (___units in total)

Plot the straight line PPFs for England and Portugal Microeconomics Topic 1: The Economic Problem Plot the straight line PPFs for England and Portugal England has 300 hours and it takes 15 hours to make wheat or 30 to make wine. If England only made wheat it would produce 300/15 = 20 wheat and no wine If England only made wine it would produce 300/30 = 10 wine and no wheat. PPF goes through (0, 20) and (10, 0) etc. Plot wine on x-axis and plot Portugal ON THE SAME GRAPH

Quick check – opportunity cost from the graph Microeconomics Topic 1: The Economic Problem Wheat Wine Portugal 30 20 England 20 10 Portugal Opportunity cost of 1 unit wheat = Opportunity cost of 1 unit wine = England

Theory of Comparative advantage Microeconomics Topic 1: The Economic Problem The theory of Comparative advantage states that countries will find it mutually advantageous to trade if comparative costs of production differ. What happens if comparative costs are identical?

Microeconomics Topic 1: The Economic Problem Exam question Explain whether country A should specialise in wheat or rice (4 marks). Use calculations Wheat Rice

Quick check – opportunity cost from the graph Microeconomics Topic 1: The Economic Problem Wheat Wine Country A 500,000 Country B Country A Opp. cost of 1 unit wheat = Opp. cost of 1 unit wine = 200,000/200,000 = 1

Microeconomics Topic 1: The Economic Problem Exam answer Microeconomics Topic 1: The Economic Problem Calculating opportunity cost: Country A has a lower opportunity cost than B in ______ (_____compared to 1kg) and so A should specialise in ______ (and similarly country B should specialise in ________). Opp. cost of 1 unit wheat Opp. cost of 1 unit rice A B Wheat Rice

Assumptions of the theory of comparative advantage Microeconomics Topic 1: The Economic Problem There are no ______________ costs (but high ______________ costs may prevent trading) Costs are constant and there’s no ___________ of scale (but EoS tend to favour specialisation) There are only two economies producing _____ goods (but theory works with multiple goods and countries) Goods are homogenous (true for ___________) Factors of _____________ are perfectly mobile No tariffs or ______________ Perfect knowledge

Microeconomics Topic 1: The Economic Problem Advantages of trade

Disadvantages of trade Microeconomics Topic 1: The Economic Problem Disadvantages of trade

What was the GDP of India (in USD) in 2015? Microeconomics Topic 1: The Economic Problem This website says: https://www.cia.gov/library/publications/the-world-factbook/rankorder/2001rank.html#in $7.965 trillion But other websites say $2.091 trillion Both figures are correct! Why?