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Chapter 33

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ECON 110
Ian James Cromb

Chapter 33 (842-855) The Gains from International Trade Gains from Trade: • Form the basis for all consumption beyond subsistence level • At the individual level if we did not specialize and trade (the division of labour) we would each have to be economically self-sufficient • Produce everything we consume -development of markets within economies • Arise spontaneously due to the gains from specialization and trade • Same logic holds at other levels -inter-regional level -international level An Individual Level Example Autarky (no trade): • Crusoe and Friday are each alone at opposite ends of an island. • Crusoe can produce either 10 coconuts or 5 fish a day (or any linear combination). Crusoe’s PPB: Crusoe’s PPB: C=10-2F (opportunity cost of 1 fish is 2 coconuts) therefore the slope of the PPB is 2. • Friday can produce either 5 coconuts or 10 fish a day (or any linear combination). Friday’s PPB: Friday’s PPB: C= 5 – ½ F (opportunity cost of 1 fish is a ½ coconut) the slope is therefore ½ • In autarky (with no trade) each person’s PPB is also his Consumption Possibilities Boundary (CPB) • Suppose in autarky, Crusoe chooses 2 fish and 6 coconuts, Friday chooses 8 fish and 1 coconut • Shown above at the point’s A-total output in autarky is 10 fish and 7 coconuts • In autarky, we’re left inside the economy wide PPB • Inefficiency in the allocation of resources • What if these two were brought into the same economy? Economy-wide PPB: Economy-Wide PPB • It is clear that the overall autarky production is inefficient since it leaves this “economy” operating inside its PPB. • Voluntary trade brings the two into the same economy. • The gains from trade allow the two to reach the economy-wide PPB. Gains from Specialization and Trade • -This change moves them closer to the economy wide PPB and the additional output is a measure of the gains from trade. • Would arise spontaneously due to the difference in opportunity costs for the two: • Any “trade price” for fish: Would cause Friday to produce more fish and trade for coconuts and would cause Crusoe to produce more coconuts and trade for fish • Both would be better off • They are sharing the gains from trade • In this way, trade allows for the division of labour and generates gains for the economy • We can also see how non-linear PPBs come about (imagine an economy with many people each of whom has a slightly different individual linear PPB). Absolute and Comparative Advantage • In our example above that Crusoe was better at producing coconuts and Friday was better at producing fish. • Crusoe could produce a coconut in 1/10 of a day while Friday took 1/5 of a day. • Friday could produce a fish in 1/10 of a day; Crusoe took 1/5 of a day. • Crusoe had an absolute advantage in the production of coconuts and Friday had an absolute advantage in the production of fish. Absolute Advantage • Aproducer has an absolute advantage when it has a lower resource cost of production (as above) or, equivalently higher productivity (more output per unit of input) • It turns out that this is not really important to the generation of the gains from trade • What is important is comparative advantage – having a lower opportunity cost • What generated the gains above was the fact that Crusoe had a lower opportunity cost of coconuts and Friday had a lower opportunity cost of fish Comparative Advantage • Aproducer a comparative advantage in the production of a good when it has a lower opportunity cost of producing that good compared to another producer • Given the reciprocal nature of opportunity cost, this implies that the other producer has a comparative advantage in the production of the other good. It is comparative advantage that leads to the gains from trade. • Shown in the following international level example International Level Example (see also example in Tables 33-1, 33-2, and 33-3) • Suppose that per unit of resources France can produce 4 cases of Red wine or 2 cases of White wine • And that per unit of resources Germany can produce 1 case of Red wine or 1 case of White w
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