Chapter 8 Trade

 The production possibilities curve tells us how we can produce from existing resources and
technology
 The basis for trade is comparative advantage
o Specialization is based on comparative, not absolute, advantage
 There are winners and losers within trading states and countries
 The winners from trade can more than compensate the losers
 Important arguments against free trade exist.

THE PRODUCTION POSSIBILITIES CURVE

 Motivation for trade?  we can all be better off if we trade with each other cuz trade
allows total production to be maximized.
 Production possibilities curve  shows the relation between the max production of one
good for given level of production for another good.
 It is like the budget constraint  it tells us how much we can produce from existing
resources and technology.
o Points on the PPC are attainable and efficient  make full use of our resources
and can be achieved.
o Points inside the PPC are attainable but Inefficient  we could produce more with
our time
o Points beyond the PPC are unattainable  it is not feasible given our skills and
available resources
 We are inside the PPC when we do not produce efficiently
o Not having the optimal ratio of workers to machines makes our production stay
inside the PPC
Calculating opportunity cost

Loss∈the fist action

Opportunity cost=
Gain∈the other action
 We get the numbers by taking the absolute value of the slope of the PPC. How do I find
the slope?  we take the rise between two points on the vertical y-axis and divide it by
the run on the horizontal x-axis.
o RISE = Amount by which doing Y changes
o RUN = Amount by which doing X changes
 The opportunity costs are reciprocals.

THE BASIS FOR TRADE: CAMPARATIVE ADVANTAGE

 Principle of comparative advantage  figuring on what one’s relatively good at.

o Ability of an individual, firm or country to produce certain good at a lower
opportunity cost than other producers.
 The key to determining who has a comparative advantage is to compare individual
opportunity costs.
 Specialization

 If one specializes in producing what one is relatively good at then they will be better off
trading.
 Specialization occurs only when a firm, individual or country focus in what they have
comparative advantage.

Absolute advantage

 Being better at both tasks means that we have absolute advantage at producing both. This
means that we have now the ability to produce more of certain product given the same
number of resources.
 Even though one can produce more in each day than the other can, there is not
comparative advantage in producing both.
o With linear PPCs (not if 2 ppl have the same opportunity cost) one will always have
a comparative advantage in producing one good and the other person the other
good.

The price of the Trade

 The terms of trade are the negotiated exchange rate of goods for goods.
 Principle of comparative advantage does not provide an exact term of trade, but it does
provide a range within which trade will occur.
 There is a range of terms of trade that would be mutually beneficial to both parties.
o It can be found by considering the opportunity costs.
 For both parts to join the trade, the trading price must lie between their opportunity
costs.
 The gains to trade shrink as the trading partners become more alike.

TRADES BETWEEN STATES

 A good that is made in California and shipped to Wisconsin is called an export for
California and an import for Wisconsin.
 The Bureau of Transportation Statistics (BTS) it keeps tracks commodity shipments from
U.S states to other countries.
o BTS  tracks of all interstate commodity shipments by state of origin and state of
destination.

Economy-Wide PPC

 We see increasing opportunity costs in the economy-wide PPC because moving to

production extremes is difficult, as some inputs are quite well suited for producing apples,
whereas other inputs are better suited for producing oranges. Thus, as you move
resources increasingly into production of one good, the opportunity cost of doing so
increases at an increasing rate.
 In the short run PPC is fixed.
 In the long run, resources are not fixed, so increases in natural resources or changes in
productivity due to population growth, changes in technology and increases in worker
education shift the PPC outward.
