Why Nations Trade

1. Why Nations Trade Chapter 18 1

2. Discussion Topics • Why trade? • Absolute advantage • Gains from trade 2

3. Concepts Affecting Trade • Absolute advantage – exists when one nation can produce goods more cheaply than another nation • Comparative advantage – ability of a nation to specialize in the production of the good for which it has lowest opportunity cost • Competitive advantage – economic competitiveness of a nation reflected in the absolute cost of a given good in a given market at a particular point in time 3 Pages 359-363

4. Comparative Advantage • Comparative advantage : If one nation is less efficient in the production of a good than another nation, there is still a basis of gains from trade • A nation should specialize in production and export the good for which its relative (comparative) advantage is greatest • A nation should specialize in production and export the good for which it has the least relative disadvantage • A nation should import the good for which its relative (comparative) advantage is the least • A nation should import the good for which it has the greatest relative disadvantage 4 Pages 359-363

5. Ratio 5.00 0.67 • U.S. is most efficient producer of wheat while Mexico is most efficient producer of coffee • With trade • U.S. • specializes in wheat • exchange part of its surplus for coffee • Mexico • specialize in coffee • trade part of the surplus for wheat 5 Page 360

6. Ratio 5.00 1.33 • Mexico→ absolute disadvantage in producing both goods • U.S.→ relative advantage greatest in wheat (10/2 vs. 4/3) • → U.S. has a comparative advantage in wheat • →Mexico has the least comparative disadvantage in coffee or comparative advantage in coffee 6 Page 361

7. Factors Affecting Comparative Advantage…. • National differences in opportunity costs • Costs affected by availability of resources • Costs affected by production requirements for goods and services produced • Costs affected by resource combinations • Costs affected by resource mobility 7 Page 362

8. We assume both countries fully employ all resources, technology and specific amounts of labor per year 8 Page 364

9. U.S./Mexico Production Possibilities U.S produces 100 tons of wheat and 40 tons of coffee. Mexico produces 32 tons of wheat and 12 tons of coffee 200 40 U.S. (tons/year) Mexico (tons/year) 175 32 150 125 24 100 16 75 50 8 25 0 0 48 40 60 24 12 60 20 80 36 9 Page 365

10. U.S./Mexico Production Possibilities B U.S. (tons/year) 200 40 Mexico (tons/year) 175 C 32 150 125 Wheat 24 Wheat 100 A 16 75 50 8 25 0 0 48 40 60 24 12 60 20 80 36 Coffee Coffee • Through trade • U.S. specializes in wheat (pt B) • Trades 50 tons of wheat to Mexico for 45 tons of coffee • Consumes more of both goods at pt C (45 tons of coffee and 150 tons of wheat) than at pt A. • Comparing C w/ A → U.S. better of with trade Page 365 10

11. U.S. (tons/year) C* 50 Mexico (tons/year) B 200 40 A* 175 C 32 150 125 Wheat 24 Wheat 100 A 16 75 50 8 25 B* 0 0 48 40 60 24 12 60 20 80 36 Coffee Coffee • Through trade • Mexico specializes in coffee, 60 tons, pt. B* and no wheat • Would trade 45 tons of coffee for 50 tons of wheat • Consume more of both goods (50 tons of wheat and 15 tons of coffee, pt C*) than at pt A* • Comparing C* w/ A* → Mexico better off with trade 11

12. Summary • The law of comparative advantage was contrasted with absolute advantage and competitive advantage. • Trade occurs because traders anticipate gains from trading. • Comparative advantage determines whynations trade. • The basis for trade is differing opportunity costs among nations. • Nationsspecializein producing those goods in which they are most efficient and exchange these goods with other nations. 12