Why do people trade?
1. Assume people didn’t trade. What things would
you have to go without?
Everything you don’t produce yourself!
(Clothes, car, cell phone, bananas, heath care, etc)
The Point: Everyone specializes in the production
of goods and services and trades it to others
2. What would life be like if cities couldn’t trade
with cities or states couldn’t trade with states?
Limiting trade would reduce people’s choices and
make people worse off.
The Point: More access to trade means more
choices and a higher standard of living.
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Copyright
ACDC Leadership 2015
Economic Basis for Trade
• Nations have different resource
endowments
• Labor-intensive goods
• Land-intensive goods
• Capital-intensive goods
LO2
Absolute and Comparative
Advantage
Copyright
ACDC Leadership 2015
3
Let’s Simplify…
4
Specialization benefits both
sides
• Shift resources to export industry
• Achieve higher overall output and
income
• Absolute advantage
–Higher output per worker for a good
• Comparative advantage
–Lower domestic opportunity cost for
a good
5-5
Comparative Advantage
Mexico’s Production Possibilities Table (in Tons)
Product
Production Alternatives
A
B
C
D
E
Avocados
0
20
24
40
60
Soybeans
15
10
9
5
0
**Optimal domestic production occurs at point C
• Opportunity cost of 1 ton of
Soybeans is 4 tons of Avocados
• Opportunity cost of 1 ton of
Avocados is .25 tons of Soybeans
5-6
Comparative Advantage
U.S.’s Production Possibilities Table (in Tons)
Product
Production Alternatives
A
B
C
D
E
Avocados
0
30
33
60
90
Soybeans
30
20
19
10
0
**Optimal domestic production occurs at point C
• Absolute advantage in both goods
• Opportunity cost of 1 ton of
Soybeans is 3 tons of Avocados
• Opportunity cost of 1 ton of
Avocados is .33 tons of Soybeans
5-7
Comparative Advantage
•
•
•
•
•
Mexico will produce avocados
U.S. will produce soybeans
U.S. gives up 3 A for 1 S
Mexico gives up 4 A for 1 S
Terms of trade
–3.5 A for 1 S
–Both countries benefit
5-8
Comparative Advantage
• Gains from trade
• Mexico starts at C (24 A and 9S)
–Move to E (60 A and 0 S)
–Trade 35 A for 10 S
• U.S. starts at C (33 A and 19 S)
–Move to A (0 A and 30 S)
–Trade 10 S for 35 A
• Overall gains?
5-9
Comparative Advantage (pg. 98)
Terms of Trade – 1s : 3.5a
Trade: 10 tons soybeans for 35 tons avocados
Homework Problem
a. What is each country’s cost ratio of producing plums and apples?
b. Which nation should
specialize in which product?
• New Zealand should produce apples and
Spain should produce plums.
c. Show the trading possibilities lines for
each nation if the actual terms of trade are 1
plum for 2 apples. (Plot these lines on your
graph.)
d. Suppose the optimum product mixes
before specialization and trade were
alternative B in New Zealand and alternative
S in Spain. What would be the gains from
specialization and trade?
Total Gain Apples = 20 (= 60 - 40);
Total Gain Plums = 10 (= 60 -50)