Unit 4: International Economics SSEIN 1 Unit 4: International Economics

SSEIN1 The student will explain why individuals, businesses, and governments trade goods and services. a. Define and distinguish between absolute advantage and comparative advantage. b. Explain that most trade takes place because of comparative advantage in the production of a good or service. c. Explain the difference between balance of trade and balance of payments.

Absolute & Comparative Advantages We trade because different people have different specialties Someone pays you for one specialty, and you take that money and trade it for someone else’s specialty This is true for individual, but it can be expanded to much larger areas as well

Absolute & Comparative Advantages Within our own country, we see regional specialization… New York: Banking/Financial Detroit: Car industry Midwest: Farming (wheat/grain) South: Agriculture (fruit)

Absolute & Comparative Advantages Our country also exports our specialties to other countries, and import their specialties

Absolute & Comparative Advantages America’s Top Exports: Semiconductors (a part used in most electronics) - $50 bil Airplanes - $49 bil Automotive parts and accessories - $44 bil New & Used cars – $44 bil America’s Top Imports: Oil - $237 bil New & Used cars - $134 bil Other Automotive parts and accessories - $73 bil Medical/Pharmaceutical/Dental Prep - $72 bil

Absolute & Comparative Advantages America’s Total Exports = $1.16 tril America’s Total Imports = $1.95 tril

Absolute & Comparative Advantages International trade is completed for the same reason individuals trade… they believe what they have a greater need for what they get than what they give Without trade, we wouldn’t have… Hondas Bananas Coffee Oil (we’d have some, but nearly enough)

Absolute & Comparative Advantages One reason a country may trade is that it is cheaper to import the good than to manufacture it within

Absolute & Comparative Advantages If a country can manufacture a product more efficiently than other countries, it has an “absolute advantage”

Absolute & Comparative Advantages Example from p. 469 in text book Take 2 countries… both are identical, except for their climate and soil; both countries have 2 crops, coffee & cashews If they both focus on coffee: “A” will produce 40 mil lbs. “B” will produce 6 mil lbs. Which has the absolute advantage? If they both focus on cashews: “A” will produce 8 mil lbs.

Absolute & Comparative Advantages For a while, economists only looked at the absolute advantage of countries, so trade between “A” and “B” wouldn’t make sense… “A” would have no benefit to trade with “B”

Absolute & Comparative Advantages “A” does have a reason to trade with “B” though because there is a “comparative advantage” A comparative advantage means that a country can produce a good at a lower opportunity cost.

Absolute & Comparative Advantages If “A” can produce either 40 mil. lbs of coffee, OR 8 mil lbs. of cashews, then their opportunity cost for 1 lb of cashews is 5 lbs of coffee. Production possibilities curve… making more “x” means you have to give up “y”… remember? In the case of cashews, 40/8 = 5 The opportunity cost for “B” is 1 lb… 6/6 = 1

Absolute & Comparative Advantages So, “A” may have the absolute advantage in producing cashews, but “B” has to give up less, so they have the comparative advantage If you flip the equation, you’ll find the opportunity cost for the opposite So for country “A”, producing 1 lb of coffee costs 1/5 lb of cashews (8/40)… “B” opportunity cost remains 1 (still 6/6)… so which has the “comparative advantage” in coffee production?

Absolute & Comparative Advantages The idea of comparative advantage assumes that everyone will be better off doing what they do best, so the final result will be increased output worldwide