Interdependence and the Gains from trade - Higher Ed eBooks ...

Interdependence and the Gains from trade - Higher Ed eBooks ...

PowerPoint Presentations for Principles of Microeconomics Sixth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Sixth Canadian Edition by Marc Prudhomme University of Ottawa INTERDEPENDENC E AND THE GAINS FROM TRADE Chapter 3 Copyright 2014 by Nelson Education Ltd.

3-2 INTERDEPENDENCE AND THE GAINS FROM TRADE One of the ten principles of economics highlighted in Chapter 1 is that trade can make everyone better off. This principle explains why people trade with their neighbours and why nations trade with other nations. What exactly do people gain when they trade with one another? Why do people choose to become interdependent? Copyright 2014 by Nelson Education Ltd. 3-3 A PARABLE FOR THE MODERN ECONOMY

Imagine that in the world there are: two goodsmeat and potatoes and two peoplea cattle rancher and a potato farmereach of whom would like to eat both meat and potatoes. It is easy to see that trade would allow them to enjoy greater variety. Copyright 2014 by Nelson Education Ltd. 3-4 A PARABLE FOR THE MODERN ECONOMY Suppose, for example, that the potato farmer is able to raise cattle and produce meat, but that he is not very good at it. Suppose that the cattle rancher is able to grow potatoes, but that her land is not very well suited for it. The farmer and the rancher can each benefit by specializing

in what he or she does best and then trading with the other. The gains from trade are less obvious, however, when one person is better at producing every good. Copyright 2014 by Nelson Education Ltd. 3-5 Production Possibilities A production possibilities frontier shows the various mixes of output that an economy can produce. It illustrates one of the ten principles of economics in Chapter 1: People face tradeoffs. Copyright 2014 by Nelson Education Ltd. 3-6 FIGURE 3.1

The Production Possibilities Frontier Copyright 2014 by Nelson Education Ltd. 3-7 Active Learning Production and Consumption with and without Trade Two countries: Canada and Japan Two goods: computers and wheat One resource: labour (measured in hours) We will look at how much of both goods each country produces and consumes: if the country chooses to be self-sufficient if it trades with the other country Copyright 2014 by Nelson Education Ltd.

3-8 Active Learning Derive Canadas PPF Use the following information to draw Canadas PPF. Canada has 50 000 hours of labour available for production per month. Producing one computer requires 100 hours of labour. Producing one ton of wheat requires 10 hours of labour. Your graph should measure computers on the horizontal axis. Copyright 2014 by Nelson Education Ltd. 3-9

Active Learning Canadas PPF Wheat (tons) 5000 Canada has enough labour to produce 500 computers, or 5000 tons of wheat, or any combination along the PPF. 4000 3000 2000 1000 0

Computers 100 200 300 400 500 Copyright 2014 by Nelson Education Ltd. 3-10 Active Learning Canada without Trade Wheat (tons) 5000 Suppose Canada uses half its labour to produce each of the

two goods. 4000 Then it will produce and consume 250 computers and 2500 tons of wheat. 3000 2000 1000 0 Computers 100 200 300 400 500

Copyright 2014 by Nelson Education Ltd. 3-11 Active Learning Derive Japans PPF Use the following information to draw Japans PPF. Japan has 30 000 hours of labour available for production per month. Producing one computer requires 125 hours of labour. Producing one ton of wheat requires 25 hours of labour. Your graph should measure computers on the horizontal axis. Copyright 2014 by Nelson Education Ltd.

3-12 Active Learning Japans PPF Wheat (tons) Japan has enough labour to produce 240 computers, or 1200 tons of wheat, or any combination along the PPF. 2000 1000 0 Computers 100

200 300 Copyright 2014 by Nelson Education Ltd. 3-13 Active Learning Japan without Trade Wheat (tons) Suppose Japan uses half its labour to produce each good. 2000

Then it will produce and consume 120 computers and 600 tons of wheat. 1000 0 Computers 100 200 300 Copyright 2014 by Nelson Education Ltd. 3-14

Active Learning Consumption with and without Trade Without trade, Canadian consumers get 250 computers and 2500 tons of wheat. Japanese consumers get 120 computers and 600 tons wheat. We will compare consumption without trade to consumption with trade. First, we need to see how much of each good is produced and traded by the two countries. Copyright 2014 by Nelson Education Ltd. 3-15 Active Learning Production under Trade 1. Suppose Canada produces 3400 tons of wheat. How

many computers would Canada be able to produce with its remaining labour? Draw the point representing this combination of computers and wheat on Canadas PPF. 2. Suppose Japan produces 240 computers. How many tons of wheat would Japan be able to produce with its remaining labour? Draw this point on Japans PPF. Copyright 2014 by Nelson Education Ltd. 3-16 Active Learning Canadas Production with TradeWheat (tons) Producing 3400 tons of wheat requires 34 000 labour hours.

5000 4000 The remaining 16 000 labour hours are used to produce 160 computers. 3000 2000 1000 0 Computers 100 200 300 400 500

Copyright 2014 by Nelson Education Ltd. 3-17 Active Learning Japans Production with Trade Wheat (tons) Producing 240 computers requires all of Japans 30 000 labour hours. 2000 So, Japan would produce 0 tons of wheat.

1000 0 Computers 100 200 300 Copyright 2014 by Nelson Education Ltd. 3-18 Active Learning Consumption under Trade Suppose Canada exports 700 tons of wheat to Japan and imports 110 computers from Japan.

(So, Japan imports 700 tons wheat and exports 110 computers.) How much of each good is consumed in Canada? Plot this combination on Canadas PPF. How much of each good is consumed in Japan? Plot this combination on Japans PPF. Copyright 2014 by Nelson Education Ltd. 3-19 Active Learning Canadas Consumption with Trade Wheat (tons) 5000

4000 3000 2000 produced + imported computers 160 110 wheat 3400 0 exported 0

700 = amount consumed 270 2700 1000 0 100 200 300 400 500

Computers Copyright 2014 by Nelson Education Ltd. 3-20 Active Learning Japans Consumption with Trade Wheat (tons) 2000 1000 0 produced

+ imported computers 240 0 wheat 0 700 exported 110 0 = amount consumed

130 700 Computers 100 200 300 Copyright 2014 by Nelson Education Ltd. 3-21 Active Learning Trade Makes Both Countries Better Off Canada

consumption without trade consumption with trade gains from trade computers 250 270 20 wheat

2500 2700 200 consumption without trade consumption with trade gains from trade computers 120

130 10 wheat 600 700 100 Japan Copyright 2014 by Nelson Education Ltd. 3-22

Active Learning Answers Point F: 100 computers, 3000 tons of wheat Wheat (tons) 6,000 5,000 Point F requires 40 000 hours of labour. Possible but not efficient: could get more of either good without sacrificing any of the other

4,000 3,000 F 2,000 1,000 0 0 100 200 300 400 500 600 Computers Copyright 2014 by Nelson Education Ltd. 3-23 Specialization and Trade

After several years of eating combination B, the rancher gets an idea and goes to talk to the farmer. Copyright 2014 by Nelson Education Ltd. 3-24 QuickQuiz Draw an example of a production possibilities frontier for Robinson Crusoe, a shipwrecked sailor who spends his time gathering coconuts and catching fish. Does this frontier limit Crusoes consumption of coconuts and fish if he lives by himself? Does he face the same limits if he can trade with natives on the island? Copyright 2014 by Nelson Education Ltd.

3-25 COMPARATIVE ADVANTAGE If the rancher is better at both raising cattle and growing potatoes, how can the farmer ever specialize in doing what he does best? The farmer doesnt seem to do anything best. To solve this puzzle, we need to look at the principle of comparative advantage. Copyright 2014 by Nelson Education Ltd. 3-26 FIGURE 3.2: How Trade Expands the Set of Consumption Opportunities Copyright 2014 by Nelson Education Ltd.

3-27 FIGURE 3.2 (continued) Copyright 2014 by Nelson Education Ltd. 3-28 Absolute Advantage Absolute advantage: the comparison among producers of a good according to their productivity Copyright 2014 by Nelson Education Ltd. 3-29

Opportunity Cost and Comparative Advantage Rather than comparing inputs required, we can compare the opportunity costs. Opportunity cost: whatever must be given up to obtain some item Copyright 2014 by Nelson Education Ltd. 3-30 TABLE 3.1: The Opportunity Cost of Meat and Potatoes Copyright 2014 by Nelson Education Ltd.

3-31 Vinko93/Shutterstock Opportunity Cost and Comparative Advantage Comparative advantage: the comparison among producers of a good according to their opportunity cost Copyright 2014 by Nelson Education Ltd. 3-32 Comparative Advantage and Trade The gains from specialization and trade are based not

on absolute advantage but rather on comparative advantage. When each person specializes in producing the good for which he or she has a comparative advantage, total production in the economy rises. Each benefits from trade by obtaining a good at a price that is lower than his or her opportunity cost of that good. Copyright 2014 by Nelson Education Ltd. 3-33 Comparative Advantage and Trade The moral of the story of the farmer and the rancher: Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage. Copyright 2014 by Nelson Education Ltd.

3-34 The Price of Trade What determines the price at which trade takes place? How are the gains from trade shared between the trading parties? For both parties to gain from trade, the price at which they trade must lie between the two opportunity costs. Copyright 2014 by Nelson Education Ltd. 3-35 QuickQuiz Robinson Crusoe can gather 10 coconuts or catch 1 fish per hour. His friend Friday can gather 30 coconuts or catch 2 fish per

hour. What is Crusoes opportunity cost of catching one fish? What is Fridays? Who has an absolute advantage in catching fish? Who has a comparative advantage in catching fish? Copyright 2014 by Nelson Education Ltd. 3-36 APPLICATIONS OF COMPARATIVE ADVANTAGE Should Sidney Crosby shovel his own sidewalk? Should Canada trade with other countries? Imports: goods and services produced abroad and sold domestically Exports: goods and services

produced domestically and sold abroad Copyright 2014 by Nelson Education Ltd. 3-37 QuickQuiz Suppose that a skilled brain surgeon also happens to be the worlds fastest typist. Should he do his own typing or hire a secretary? Explain. Copyright 2014 by Nelson Education Ltd. 3-38 Classroom Activity A Short Trip with Many Contributors

Answer the following questions. 1. Think of a recent trip you have taken. The distance travelled is unimportant, just choose a specific trip. Where did this trip start and finish? 2. Who produced the goods and services that made your trip possible? (List as many types of workers as possible.) 3. How were the different elements of your trip financed (e.g., the vehicle, the road network, or the airport)? Copyright 2014 by Nelson Education Ltd. 3-39 THE END Chapter 3 Copyright 2014 by Nelson Education Ltd.

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