More on trade issues Today: Review of Test 1 Finishing comparative advantage Introducing international trade

Who is this? Come to class to find out We will find out why he has made significant contributions to trade theory

Comparative advantage We have done the basics of comparative advantage Today We apply these principles, including to international trade

Today Comparative advantage and specialization An introduction to trade Addressing concerns about trade

Example Productivity in pizza production Productivity in salad production Greg20 pizzas cooked per hour 10 salads made per hour David16 pizzas cooked per hour 4 salads made per hour

Drop units to save space Notice that Greg has absolute advantage in producing both pizzas and salads However, we will see that each person has a comparative advantage in producing one of the goods Productivity in pizza production Productivity in salad production Greg20 / hour10 / hour David16 / hour4 / hour

Comparative advantage Before we can determine comparative advantage, we must ask about each person “how much of ____ must I give up in order to produce an additional ____?” In other words, we need to determine the opportunity cost of making one more pizza or one more salad for both Greg and David

Recall this table Productivity in pizza production Productivity in salad production Greg20 pizzas cooked per hour 10 salads made per hour David16 pizzas cooked per hour 4 salads made per hour

Opportunity cost table Note that the two numbers in each row are mathematical inverses of each other Opportunity cost of cooking a pizza Opportunity cost of making a salad Greg½ salad2 pizzas David¼ salad4 pizzas

Comparative advantage To find comparative advantage for each person, find the lowest number in each column Opportunity cost of cooking a pizza Opportunity cost of making a salad Greg½ salad2 pizzas David¼ salad4 pizzas

Comparative advantage David has comparative advantage in cooking pizzas Greg has comparative advantage in making salads Opportunity cost of cooking a pizza Opportunity cost of making a salad Greg½ salad2 pizzas David¼ salad4 pizzas

Some things to note Absolute advantage The same person could have absolute advantage in everything Comparative advantage in a two- person, two-good economy Each person will almost always have comparative advantage in exactly one of the two goods

From Greg and David to a big economy To produce an efficient point in an economy, each good needs to be produced with lowest opportunity cost All units in this graph in millions

From Greg and David to a big economy Notice that opportunity cost of pizzas increases from A to C Opportunity cost increases as more is produced All units in this graph in millions

Changes in a production possibilities curve Some factors that can shift a production possibilities curve Change in population War Investment in buildings, machines, and other forms of capital Research and development in technology

From comparative advantage to trade Recall that Greg had comparative advantage at making salads, while David’s was making pizzas Greg could make more salads than he wants to eat and trade them for pizzas from David Both can be made better off with trade

International trade In the real world, trade is more complex than simple two-good economies When trade becomes more open between countries, there are typically millions of winners and often only thousands of losers Prices go down for goods on average The few displaced workers must find an alternate form of work, typically at a lower wage

Addressing concerns about trade “A majority of Americans, including 60 percent of Republicans, now believe free trade is bad for the U.S. economy, according to recent NBC News-Wall Street Journal polls.” (Source: “Trade jitters, anti-China sentiment rouse US voters,” Reuters, Nov. 14, 2007) Why do so many Americans have this opinion about trade?

Trade has costs and benefits When another country can produce goods lower than in the United States, two things happen Jobs are lost in the United States Consumers pay lower prices for the good that is now imported The news media usually focuses on the jobs issue more than about prices

Why is media coverage skewed? Any job lost seriously deteriorates the quality of life of an individual Most people don’t care to read headlines advertising “The price of rice goes down by two cents per pound” However, small gains on many products lead to substantial increases in the purchasing power of the dollar

Suppose there is protectionism elsewhere The United States is a leading exporter of fresh fruit (see on-line reading list for source) Suppose that other countries outlawed the import of fresh fruit US jobs lost Decrease in price of fruit in the US Increase in the price of fruit in other countries

Protectionist policies Suppose that protectionist policies were implemented Also suppose that these policies lead to the price of goods on average increasing by 10 to 20 percent Would you be in favor of this?

Another issue: Lead in toys Recently, many toys manufactured in China have been recalled due to unsafe levels of lead This has raised concerns about the viability of toy exports China will stop exporting toys if the world does not view the toys as safe enough, given the price

Monitoring is costly Monitoring toys for lead is costly, adding to the cost of toys purchased However, testing costs may be small relative to the additional revenues that can be generated if the delivery of “safe toys” can be guaranteed

Another example: American cars Over the last 30 years, American cars have often been looked at as “inferior” compared to some foreign models With competition from trade, domestic car producers must keep costs down and quality up in order to successfully sell cars in the domestic market The same thing goes for foreign toys If quality control standards are not maintained abroad, people will buy their toys domestically

Trade issues There are many other issues that are related to trade If you would like an in-depth analysis of trade, you can enroll in a class that deals with trade Wednesday, we will talk about the basic issues of trade, and who the winners and losers are

International trade We will examine more about international trade in the next lecture Next lecture: More on the mathematical analysis of international trade Look at lecture slides (no new reading) Think about how trade benefits your everyday life Example: You could speculate about the price of gas if OPEC countries stopped producing oil