Sit at the indicated table. Move/turn chairs where necessary.

There are two countries. West East

In each country, there are 20 workers. West East

The workers make RED stuff and BLUE stuff. West East

The workers eat the RED stuff and BLUE stuff. West East

Happiness = (RED stuff eaten) (BLUE stuff eaten) 126

In West, a single worker can produce 2 RED stuff or 1 BLUE stuff West

In East, a single worker can produce 1 RED stuff or 2 BLUE stuff East

You must decide how many workers to allocate to the production of RED stuff and how many to allocate to the production of BLUE stuff. Your goal is to attain the most happiness possible.

Example (using West): Suppose you choose to assign 2 Workers to RED production and 18 Workers to BLUE production Production of RedProduction of BlueUnits of RedUnits of BlueUnits of RedUnits of Blue Labor Allocation (must total 20)ProductionImports (negative = exports) Units of RedUnits of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed)

Example (using East): Suppose you choose to assign 3 Workers to RED production and 17 Workers to BLUE production Production of RedProduction of BlueUnits of RedUnits of BlueUnits of RedUnits of Blue Labor Allocation (must total 20)ProductionImports (negative = exports) Units of RedUnits of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed)

Round 1: Autarky Allocate 20 workers to maximize happiness.

Now, you may produce, exchange, then consume. West East

Example (using East): Suppose you choose to assign 3 Workers to RED production and 17 Workers to BLUE production. Then, West agrees to trade you 10 RED for 8 BLUE Production of RedProduction of BlueUnits of RedUnits of BlueUnits of RedUnits of Blue Labor Allocation (must total 20)ProductionImports (negative = exports) Units of RedUnits of Blue Consumption (production plus imports) Happiness (red consumed x blue consumed) 10-8

Round 2: Trade Allocate 20 workers then trade (if you want) to maximize happiness.

West has an absolute advantage in the production of RED stuff.  In West, 1 unit of RED costs 1/2 worker.  In East, 1 unit of RED costs 1 worker. East has an absolute advantage in the production of BLUE stuff.  In West, 1 unit of BLUE costs 1 worker.  In East, 1 unit of BLUE costs 1/2 worker.

What if West is a lesser developed country such that East has an absolute advantage in the production of both RED and BLUE?

In West, a single worker can produce 2 RED stuff or 1 BLUE stuff West

In East, a single worker can produce 3 RED stuff or 2 BLUE stuff East

Round 3: Autarky Allocate 20 workers to maximize happiness.

East has an absolute advantage in the production of RED stuff.  In West, 1 unit of RED costs 1/2 worker.  In East, 1 unit of RED costs 1/3 worker. East has an absolute advantage in the production of BLUE stuff.  In West, 1 unit of BLUE costs 1 worker.  In East, 1 unit of BLUE costs 1/2 worker.

Round 4: Trade Allocate 20 workers then trade (if you want) to maximize happiness.

Are we thinking about the problem correctly? When you choose to produce more RED stuff, what do you give up? When you choose to produce more BLUE stuff, what do you give up? A country doesn’t give up workers when it produces stuff. It gives up the other stuff it could be producing instead.  The opportunity cost of BLUE stuff isn’t a worker.  The opportunity cost of BLUE stuff is RED stuff!

How many RED stuff does West have to give up to produce 1 more unit of BLUE stuff?  In West, the cost of 1 BLUE stuff is 2 RED stuff. How many BLUE stuff does West have to give up to produce 1 more unit of RED stuff?  In West, the cost of 1 RED stuff is 1/2 of a BLUE stuff.

How many RED stuff does East have to give up to produce 1 more unit of BLUE stuff?  In East, the cost of 1 BLUE stuff is 3/2 RED stuff. How many BLUE stuff does East have to give up to produce 1 more unit of RED stuff?  In East, the cost of 1 RED stuff is 2/3 of a BLUE stuff.

West has a relative advantage in the production of RED stuff.  In West, 1 unit of RED costs 1/2 units of BLUE.  In East, 1 unit of RED costs 2/3 units of BLUE. WestEast East has a relative advantage in the production of BLUE stuff.  In West, 1 unit of BLUE costs 2 units of RED.  In East, 1 unit of BLUE costs 3/2 units of RED. WestEast

West has a relative advantage in the production of RED stuff.  In West, 1 unit of RED costs 1/2 units of BLUE.  In East, 1 unit of RED costs 2/3 units of BLUE. WestEast West will trade if West can sell 1 RED for more than 1/2 BLUE. East will trade if East can buy 1 RED for less than 2/3 BLUE.

West will trade if West can buy 1 BLUE for less than 2 RED. East will trade if East can sell 1 BLUE for more than 3/2 RED. East has a relative advantage in the production of BLUE stuff.  In West, 1 unit of BLUE costs 2 units of RED.  In East, 1 unit of BLUE costs 3/2 units of RED. WestEast

Conclusions: 1.Trade is a positive sum relationship. 2.Exchanging goods is what’s important. Money is only a tool that facilitates the exchanging. 3.Every country has a relative advantage in something. 4.Trade is the combination of exchange and specialization. Specialization is the directing of resources toward the countries relative advantage.

What Are the Benefits From Trade? Protectionist Assumption: Trade leads to a centralization of political power, decreased competition, and the transfer of wealth. Globalist Assumption: Trade leads to a decentralization of political power, increased competition, and the creation of wealth.

What Is the Impact on Per-Capita Income? Protectionist Assumption: Trade is exploitive of peoples and industries, therefore per- capita income will be lower for countries that trade more. Globalist Assumption: Trade is beneficial to both parties, therefore per-capita income will be higher for countries that trade more.

Per-Capita Income Luxembourg Belgium Ireland Netherlands Japan US Bahrain Source: International Financial Statistics, International Monetary Fund, December 2001

Per-Capita Income (Lower Middle, and Low Income) Suriname Lithuania Samoa Russia Colombia Peru Guyana Source: International Financial Statistics, International Monetary Fund, December 2001

Per-Capita Income Vietnam Workers in foreign-owned apparel and footwear factories rank in the top 20% of wage earners. Indonesia In 2000, Nike paid $720 annually compared with an average annual country-wide wage of $241. Mexico Firms that exported most or all of their product paid wages 60% higher than wages of non-exporting firms. Source:Brown, Drusilla K., Alan V. Deardorff, and Robert M. Stern, “The Effects of Multinational Production on Wages and Working Conditions in Developing Countries,” discussion paper no. 483, School of Public Policy, The University of Michigan, August 2002.

What Is the Impact on Income Distribution? Protectionist Assumption: Trade consolidates income in the hands of the powerful, therefore countries that trade more will have a less equitable income distribution. Globalist Assumption: Trade creates income across trading partners, therefore countries that trade more will have a more equitable income distribution.

Income Distribution US Switzerland Ireland Finland Cyprus Netherlands Singapore Hong Kong Norway Denmark Sweden Austria Canada Germany Israel France Slovenia Gabon South Africa Malaysia Source:International Financial Statistics, International Monetary Fund, December 2001, and Measuring Income Inequality: A New Database, Deininger, Klaus, and Lyn Squire, World Bank, 2002 No carrot:A too inequitable distribution signals a lack of entrepreneurial opportunity. No stick:A too equitable distribution signals no cost to free riders.

Income Distribution (Lower Middle, and Low Income) Thailand Lithuania Fiji Ukraine Source:International Financial Statistics, International Monetary Fund, December 2001, and Measuring Income Inequality: A New Database, Deininger, Klaus, and Lyn Squire, World Bank, 2002

What Is the Impact on Social Equality? Protectionist Assumption: Trade exploits the weak. Globalist Assumption: Trade empowers the weak.

Gender Related Development Index US Myanmar Oman Botswana Ivory Coast Azerbaijan and Albania GDI measures equality of quality of life (longevity, education, literacy, income). Source:International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002

Gender Empowerment Measure GEM measures the proportion of women in legislatures, among senior officials, and holding technical and management positions as well as gender differences in income (as a proxy for economic power) Source:International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002

Child Labor US Hong Kong Sierra Leone Burundi Gabon Botswana Source:International Financial Statistics, International Monetary Fund, December 2001, and World Development Indicators, World Bank, 2002

What Is the Impact on Unemployment? Protectionist Assumption: Trade destroys jobs. Globalist Assumption: Trade creates jobs. (beware of the “information availability” problem)

Unemployment vs. Trade Over Time Source: Bureau of Labor Statistics, and Bureau of Economic Analysis

Unemployment vs. Trade Over Time Source: Bureau of Labor Statistics, and Bureau of Economic Analysis

What About Outsourcing? Protectionist Assumption: Outsourcing puts Americans out of work. Globalist Assumption: Outsourcing is trade (of labor), and trade is beneficial.

Source: Balance of Payment Statistics Yearbook, IMF

Name two metrics that distinguish the first world from the third world.

If you hit a light bulb with a hammer, will you make a mess?

Source: United Nations International Financial Statistics and Heritage Foundation

Source: United Nations International Financial Statistics and Heritage Foundation

Political freedom makes economic freedom possible. Economic freedom makes political freedom meaningful.