Why Nations Trade? If we are better at making everything, why would we trade with anyone else?

Resource Distribution The Factors of Production Land All natural resources Labor Work and skills of people Capital Objects used to produce other goods Entrepreneurs The people who put it all together

Resource Distribution As you would expect resources are not distributed equally between countries. This is true of ALL Factors of Production Because of this countries should trade

Absolute Advantage Absolute advantage The ability to produce more of a product using a given amount of resources For example: We have Todd and Wendy

Absolute Advantage Given more than enough supplies And one hour in which to build birdhouses

Absolute Advantage Todd can build 2 Birdhouse Wendy can build 8 Birdhouses

Absolute Advantage Thus we say that Wendy has an Absolute Advantage over Todd when it comes to making Birdhouses. Things to Remember: Time is a resource (It is a part of “labor”) Absolute Advantage is an advantage over someone else at making that one product A product can be a good or service

Comparative Advantage The ability to produce a product most efficiently given all the other products that could be produced (w/ lowest opportunity cost) Example: Given more than enough supplies and given one hour to work . . .

Comparative Advantage Todd can make two kites Wendy can make four kites

Comparative Advantage What is Todd’s opportunity costs? 1 hour = 2 birdhouses 1 hour = 2 kites 2 birdhouses = 2 kites 1 birdhouse = 1 kite Opportunity cost of 1 birdhouse 1 Kite Opportunity cost of 1 kite 1 birdhouse

Comparative Advantage What is Wendy’s opportunity costs? 1 hour = 8 birdhouses 1 hour = 4 kites 8 birdhouses = 4 kites 1 birdhouse = ½ kite Opportunity cost of 1 birdhouse ½ Kite Opportunity cost of 1 kite 2 birdhouses

Comparative Advantage Thus Wendy has a comparative advantage of building birdhouses over kites. For an hour of work she can make more birdhouses than kites One hour of work produces an equal number of products for Todd, so we have to compare his production of each item to Wendy’s to see who should produce what.

Comparative Advantage Things to remember: Comparative advantage is an advantage in producing one product over another for ONE person or country. It is NOT a comparison between people or countries. This example assumes birdhouses and kites are worth the same amount.

Why Trade is Good In a trade, both sides can benefit. In a good trade, both sides end up better off than they were Wendy has an absolute advantage over Todd in producing Kites and Birdhouses. Given that Wendy is better at making both kites and birdhouses, why would she trade with Todd?

Why Trade is Good Suppose Wendy and Todd agree to trade. She will give him three birdhouses And he will give her two kites

Why Trade is Good For Todd two kites represent how much work? 1 hour If Todd had spent that hour making birdhouses instead of kites how many birdhouses would he have? 2 birdhouses Because of the trade, how many birdhouses does Todd have for that 1 hour of work? 3 birdhouses Thus Todd is better off because of the trade

Why Trade is Good For Wendy four birdhouses represent how much work? ½ hour (30 minutes) If Wendy had spent 30 minutes making kites instead of birdhouses how many kites would she have? 2 kites Because of the trade, what does Wendy have for that ½ hour of work? 2 kites AND 1 birdhouse Thus Wendy is better off because of the trade

Why Trade is Good Notice how both people are better off. Since Todd is worse at making both products, it makes sense that by trading with Wendy he is better off. Even though Wendy is better at making both products, by trading with Todd she is better off too. This is why international trade is good This is also why all countries should produce those products that they have a comparative advantage over, even if they don’t have an absolute advantage over other countries

The U.S. The U.S. is the world’s leading exporter We export a wide range of goods and services Germany and Japan are 2nd and 3rd The U.S. is the world’s leading importer $1.4 trillion dollars worth every year (17.3% of the world’s total) Germany and Japan are 2nd and 3rd (but the U.S. imports more than both of them combined

Trade and Unemployment Making sure we produce those goods that we have a Comparative Advantage in producing causes unemployment Can you see why? Because as technology and new inventions are created, the products we have a comparative advantage on change Thus what we should be producing changes and this creates what types of unemployment? Structural