Overview
This lecture discusses the reasons for trade, introduces the concepts of absolute and comparative advantage, and uses a model to show how countries can gain from specializing and trading.
Why Trade Makes Sense
- Trade allows people and countries to consume more than they could produce on their own.
- Two-country model: U.S. and Japan each produce only computers and tomatoes, using only labor.
- Without trade, each country consumes only what it produces, limited by labor resources.
Exports and Imports
- An export is a good produced domestically and sold abroad.
- An import is a good produced abroad and sold domestically.
Effects of Trade on Consumption
- With trade, the U.S. exports tomatoes and imports computers; Japan does the opposite.
- After trading, both countries can consume combinations of goods outside their production possibility frontier (PPF), meaning higher consumption than possible when self-sufficient.
- For example, U.S. can consume more computers and tomatoes after trade than before; the same is true for Japan.
Gains from Trade
- Both countries are better off after trade, though the gains do not need to be equal.
- The important factor is that each country is better off compared to not trading.
Specialization and Advantage
- Countries gain from specializing in goods they produce more efficiently and trading for those they do not.
- The analysis depends on understanding different types of advantage.
Absolute vs. Comparative Advantage
- Absolute advantage: producing a good using fewer resources (lower cost) than another country.
- In the example, the U.S. has an absolute advantage in tomato production (uses fewer labor hours per ton).
- Gains from trade depend more on comparative advantage (lowest opportunity cost), not just absolute advantage.
Key Terms & Definitions
- Production Possibility Frontier (PPF) — the combinations of goods a country can produce given its resources and technology.
- Export — a good produced domestically and sold abroad.
- Import — a good produced abroad and sold domestically.
- Absolute Advantage — the ability to produce a good with fewer resources than another producer.
- Comparative Advantage — the ability to produce a good at a lower opportunity cost than another producer.
- Opportunity Cost — the value of the next-best alternative given up when making a choice.
Action Items / Next Steps
- Review the concepts of absolute and comparative advantage.
- Prepare for the next lecture on comparative advantage and opportunity cost.