2. Reasons for Trade
Abraham Lincoln was once advised to buy cheap iron rails
from Britain to finish the transcontinental railroad. He
replied, "It seems to me that if we buy the rails from
England, then we've got the rails and they've got the
money. But if we build the rails here, we've got our rails
and we've got our money."
To paraphrase: "If I buy meat from the butcher, then I
get the meat and he gets my money. But if I raise a cow in
my backyard for three years and slaughter it myself, then
I've got the meat and I've got my money.“
3. "You could say that globalization, driven not by human
goodness but by the profit motive, has done far more good
for more people than all the foreign aid and soft loans
provided by well-intentioned governments and aid
agencies."
-Paul Krugman
What evidence is there to support Krugman's claim?
What evidence is there to refute it?
4. 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
5. Opportunity cost: the cost to society of producing a
particular good is what it could have produced with
those resources instead. The opportunity cost is
what was given up in order to produce something.
Comparative advantage: When a country can produce
a good or service at a lower domestic opportunity cost
than a potential trading partner.
Absolute advantage: When a country can produce a
particular good or service more efficiently than
another country. Fewer resources
are required to produce a particular good.
6. The principle of comparative advantage: says that
total output will be greatest when each nation produces
the good for which it has the lowest domestic
opportunity cost. Nations should specialize in the goods
they produce at the lowest opportunity cost, and trade
with other nations for other goods in which they do not
have a comparative advantage.
7. Goods Televisions Financial
Services
Country
China 50 40
UK 10 30
8. •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?
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9. PPC for China and the UK
TVs
50
China
10 UK
30 40
Financial services
Production Possibilities Curve shows the different
quantities of two goods that an economy could
efficiently produce with limited productive
resources
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10. 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.
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11. Should China and the UK trade? If so, who should
specialize 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 financial
services. To produce 1 TV it must give up 3 financial
services. 1 financial service only "costs" .33 TVs.
Financial services "cost" the UK less than they do
China. TVs "cost" China less than they do the UK.
China should produce TVs, the UK financial services
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