# Principles of Economics

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1 Principles of Economics LEARNING OBJECTIVES Ohio Wesleyan University Goran Skosples 3. Interdependence and the Gains from Trade Why do people and nations choose to be economically interdependent? How can trade make everyone better off? What is absolute advantage? What is comparative advantage? How are these concepts similar? How are they different? 1 Interdependence Every day you rely on many people from around the world, most of whom you do not know, to provide you with the goods and services you enjoy. hair gel from Cleveland, OH cell phone from Taiwan dress shirt from China coffee from Kenya Our Example Two countries: the U.S. and Japan Two goods: computers and wheat One resource: labor, measured in hours We will look at how much of both goods each country produces and consumes if the country chooses to be self-sufficient if it trades with the other country Trade can make everyone better off. 2 3

2 Production Possibilities in the U.S. The U.S. has 5, hours of labor available for production, per month. Producing one computer requires 1 hours of labor. Producing one ton of wheat requires 1 hours of labor. 5, 4, 3, 2, 1, The U.S. PPF The U.S. has enough labor to produce 5 computers, or 5 tons of wheat, or any combination along the PPF , 4, 3, 2, 1, The U.S. Without Trade 1 Suppose the U.S. uses half its labor to produce each of the two goods. Then it will produce and consume computers and tons of wheat A C T I V E L E A R N I N G 1: Derive Japan s PPF Use the following information to draw Japan s PPF. Japan has 3, hours of labor available for production, per month. Producing one computer requires 125 hours of labor. Producing one ton of wheat requires 25 hours of labor. Your graph should measure computers on the horizontal axis. 6 7

3 Japan s PPF Japan Without Trade 2, 1, Japan has enough labor to produce computers, or tons of wheat, or any combination along the PPF. 2, 1, Suppose Japan uses half its labor to produce each of the two goods. Then it will produce and consume 12 computers and 6 tons of wheat Consumption With and Without Trade Without trade, U.S. consumers get 25 computers and 25 tons wheat. Japanese consumers get 12 computers and 6 tons wheat. We will compare consumption without trade to consumption with trade. First, we need to see how much of each good is produced and traded by the two countries. A C T I V E L E A R N I N G 2: Production under trade 1. Suppose the U.S. produces 34 tons of wheat. How many computers would the U.S. be able to produce with its remaining labor? Draw the point representing this combination of computers and wheat on the U.S. PPF. 2. Suppose Japan produces 24 computers. How many tons of wheat would Japan be able to produce with its remaining labor? Draw this point on Japan s PPF. 1 11

4 5, 4, 3, 2, 1, U.S. Production With Trade Producing 34 tons of wheat requires labor hours. The remaining labor hours are used to produce computers. 2, 1, Japan s Production With Trade Producing 24 computers requires all of Japan s labor hours. So, Japan would produce tons of wheat International Trade Exports: goods produced domestically and sold abroad Imports: goods produced abroad and sold domestically A C T I V E L E A R N I N G 3: Consumption under trade Suppose the U.S. exports 7 tons of wheat to Japan, and imports 11 computers from Japan. (So, Japan imports 7 tons wheat and exports 11 computers.) How much of each good is consumed in the U.S.? Plot this combination on the U.S. PPF. How much of each good is consumed in Japan? Plot this combination on Japan s PPF

8 CHAPTER SUMMARY Interdependence and trade allow everyone to enjoy a greater quantity and variety of goods & services. Comparative advantage means being able to produce a good at a lower opportunity cost. Absolute advantage means being able to produce a good with fewer inputs. When people or countries specialize in the goods in which they have a comparative advantage, the economic pie grows and trade can make everyone better off. 28

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