Notes - Interdependence Trade can make everyone better off...

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Interdependence Trade can make everyone better off. We will now learn why people and nations choose to be interdependent and how they gain from trade. Specialization You do what you do best; I'll do what I do best; and we'll trade off and both benefit. Our Example: Two countries: US and Japan Two goods: computers and wheat One resource: labor (measured in hours) We will look at the amount of each good both countries consume if the choose to be self- sufficient vs if they trade with each other. Production Possibilities in the U.S. The U.S. has 50,000 hours of labor available for production per month. Producing one computer requires 100 hours of labor. Producing one ton of wheat requires 10 hours of labor. What is maximum potential for producing computers? 500 computers What is maximum potential for producing wheat? 5,000 tons of wheat Production Possibilities of Japan Japan has 30,000 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. What is maximum potential for producing computers? 240 computers What is maximum potential for producing wheat? 1200 tons of wheat Production under Trade Suppose the US produces 3400 tons of wheat using 34000 hours. How many computers? 16,000 hours of labor left produces 160 computers. Suppose Japan produces 240 computers using 30,000 hours. 0 hours of labor left produces no wheat. Trade off yields a 20 computer/200 tons of wheat gain for US Trade off yields a 10 computer/100 tons of wheat gain for Japan International Trade Exports: goods produced domestically and sold abroad. Imports: goods produced abroad and sold domestically. Where do these gains come from? Absolute advantage: the ability to produce a good using fewer inputs than another producer. The US has an absolute advantage in the production of wheat: US uses 10 labor hours for wheat while Japan requires 25 hours.
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The US also has an absolute advantage in computers: US requires 100 hours per computer vs Japan requires 125 hours per computer. The US has and absolute advantage in both goods. So why does Japan specialize in computers? Two Measures of the Cost of a Good Two countries can gain from trade when each specializes in the good it produces at the lowest cost. Absolute advantage measures the cost of a good in terms of the inputs required to produce it. Recall: Another measure of cost is opportunity cost Opportunity Cost and Comparative Advantage Comparative Advantage: the ability to produce a good at a lower opportunity cost than the other producer. The opportunity cost of a computer is:
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Notes - Interdependence Trade can make everyone better off...

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