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Chapter 33

Economics 102: Chapter 33

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ECON 102
Robert Gateman

Economics 102: Principles of Macroeconomics Chapter 33 33.1 The Gains from Trade  Open economy: an economy that engages in international trade  Closed economy: an economy that has no foreign trade (autarky) Interpersonal, Interregional, and International Trade:  If there was no trade, individuals would have to be very self-sufficient (low living standards) o Trade allows people to specialize in activities that they do well, and buy what they cannot make  Each region can also focus on what they specialize growing, making, etc. o Living standards will be higher if each region is able to specialize in a product or service  Gains from trade: the increased output attributable to the specialization according to comparative advantage that is made possible by trade Illustrating the Gains from Trade:  Average cost of production of any good is independent of how much of that good is produce (assumption) Absolute Advantage:  When one country can produce some commodity at lower absolute cost than another country o Fewer inputs of resources to produce a given amount of outputs  Absolute cost: the dollar cost of labour, capital and other resources required to produce the goods o Country that can produce a good with fewer resources can produce it at a lower absolute cost Comparative Advantage:  When a country can produce a good with less forgone output of other goods that can another country o Based on opportunity cost rather than absolute cost  A country may have an absolute advantage in all goods, but not a comparative advantage  A country may be inefficient in absolute terms but must have a comparative advantage in some goods  Gains from specialization and trade depend on the pattern of comparative, not absolute advantage  World output increases if countries specialize in the production of the goods in which they have a comparative advantage  Specialization of production against the pattern of comparative advantage leads to a decline in total world output  Existence of different opportunity costs across countries implies comparative advantage that can lead to gains from trade Economics 102: Principles of Macroeconomics The Gains from Trade with Variable Costs:  If costs vary with the level of output, or as experience is acquired via specialization, additional gains are possible Economies of Scale:  Larger the scale of operations, the more efficiently large-scale machinery can be used and the more a detailed division of tasks among workers is possible o Countries not large enough to exploit economies of scale are unable to produce everything  An increase in the size of the market, even in a large economy, may allow the exploitation of some previously unexploited scale economies in individual product lines  Free trade is able to allow proliferation of differentiated products from specializing countries o Consumers value a range of differentiated products, and producer have gained from economies of scale, by operating at a larger scale Learning by Doing:  Reduction in unit costs that often results as workers learn through repeatedly performing the same tasks o It causes a downward shift in the average cost curve o Important in knowledge intensive high-tech industries  Through education and tax incentives, policy makers can develop new comparative advantages o Countries cannot assume that their existing comparative advantage will persist  Misguided education policies, wrong tax incentives, or policies that discourage risk taking can lead to the rapid erosion of a comparative advantage Sources of Comparative Advantage:  Gains from trade arise from the pattern of comparative advantage Different Factor Endowments:  International cost advantage arises because factor endowments differ across countries  A country well-endowed with land but has a small population will have cheap land, but expensive labour o Produce land-intensive agricultural goods cheaply and labour-intensive goods at a higher cost o Comparative advantage in agricultural production  Heckscher-Ohlin theory: countries have comparative advantages in the production of goods that use intensively the factor of production with which they are abundantly endowed  Canada has a comparative advantage in goods that use forest products intensively o Comparative disadvantage in goods that use labour intensively Different Climates:  Climate affects comparative advantage (sunshine, rainfall, temperature, etc.)  Only some products are able to be grown in particular countries Economics 10
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