Reasons for TradeAbraham Lincoln was once advised to buy cheap iron railsfrom Britain to finish the transcontinental railroad. Hereplied, "It seems to me that if we buy the rails fromEngland, then weve got the rails and theyve got themoney. But if we build the rails here, weve got our railsand weve got our money."To paraphrase: "If I buy meat from the butcher, then Iget the meat and he gets my money. But if I raise a cow inmy backyard for three years and slaughter it myself, thenIve got the meat and Ive got my money.“
"You could say that globalization, driven not by humangoodness but by the profit motive, has done far more goodfor more people than all the foreign aid and soft loansprovided by well-intentioned governments and aidagencies." -Paul KrugmanWhat evidence is there to support Krugmans claim?What evidence is there to refute it?
Why do nations trade?Three facts help answer this question:• Uneven distribution of natural, human and capital resources• Efficient production requires different combinations of resources• People may simply prefer products made in other countries due to non-price attributes
Opportunity cost: the cost to society of producing aparticular good is what it could have produced withthose resources instead. The opportunity cost iswhat was given up in order to produce something.Comparative advantage: When a country can producea good or service at a lower domestic opportunity costthan a potential trading partner.Absolute advantage: When a country can produce aparticular good or service more efficiently thananother country. Fewer resourcesare required to produce a particular good.
The principle of comparative advantage: says thattotal output will be greatest when each nation producesthe good for which it has the lowest domesticopportunity cost. Nations should specialize in the goodsthey produce at the lowest opportunity cost, and tradewith other nations for other goods in which they do nothave a comparative advantage.
•Who has the absolute advantage in television production? ________________ Financial services? ________________. •Who has the comparative advantage in television production? __________________ Financial services? __________________. •How do you know? •Should trade take place? If so, who should produce what?5/31/2012
PPC for China and the UKTVs50 China10 UK 30 40 Financial servicesProduction Possibilities Curve shows the differentquantities of two goods that an economy couldefficiently produce with limited productiveresources5/31/2012
PPC analysis: •Clearly China has an absolute advantage in both TVs and financial services. •With its existing resources, China can produce more TVs and more financial services than the UK.5/31/2012
Should China and the UK trade? If so, who shouldspecialize in what?•China can either produce 50 TVs or 40 financial services.To produce one TV it must give up 0.8 financial services.1 financial service "costs" China 1.25 TVs•The UK can either produce 10 TVs or 30 financialservices. To produce 1 TV it must give up 3 financialservices. 1 financial service only "costs" .33 TVs.Financial services "cost" the UK less than they doChina. TVs "cost" China less than they do the UK.China should produce TVs, the UK financial services5/31/2012