Which country among 1 and 2 will import good X and which will import good Y?
Answers
Answer:
Explanation:The American statesman Benjamin Franklin (1706–1790) once wrote: “No nation was ever ruined by trade.” Many economists would express their attitudes toward international trade in an even more positive manner.
The evidence that international trade confers overall benefits on economies is very strong. Trade has accompanied economic growth in Canada and around the world. Many economies that have shown the most rapid growth in the last few decades—for example, Japan, South Korea, China, and India—have done so by dramatically orienting their economies toward international trade. To understand the benefits of trade, or why we trade in the first place, we need to understand the concepts of comparative and absolute advantage.
Production Possibilities with Trade
In the previous section, we stated that points outside the PPF were not possible given our constraints. With trade, these constraints can change. Continuing the example from Chapter 2.2, suppose another person, Jamie, becomes stranded on the island with you. You could choose to avoid him and live your own separate lives, or you could work together to improve each other’s well-being. It turns out Jamie has different skills than you – he is better at producing both crabs and pineapples. (See Figure 2.3a)
Figure 2.3a
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Figure 2.3b
In this case, where one person or group is better at producing both goods, we say they have an Absolute Advantage in the production of the good. In this example, Jamie has the absolute advantage in the production of both goods. This means Jamie’s entire PPF lies outside of yours. (See Figure 2.3b)
Between the two of you, you are producing 70 pineapples and 28 crabs. Is this efficient? Recall that a situation is efficient if there are no available Pareto Improvements. If we can get more pineapples and crabs without having to give anything up, then the situation is inefficient.
By simply changing both yours and Jamie’s production points, we see that this is inefficient. If you were to produce 30 pineapples and 14 crabs while Jamie was to produce 40 pineapples and 18 crabs, the aggregate production would be 70 pineapples and 32 crabs – four more crabs than before! It is now clear that the previous situation was inefficient. You can trade 10 of your pineapples for 6 crabs, which leaves the following allotment of resources:
With Trade
You: 20 pineapples and 20 crabs
Jamie: 50 pineapples and 12 crabs
Each of you walks away with two more crabs than before. This is what we mean when we talk about gains from trade. Both you and Jamie are now able to produce at a point outside your PPF’s. To understand where these extra crabs come from, we must first explore the concept of comparative advantage.
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Figure 2.3c
Application
(Credit: Chad Teer/ Wikimedia/ CC-BY-2.0)
It’s All About Oil
A country has an absolute advantage in producing if it uses fewer resources to produce. Absolute advantage can be the result of a country’s natural endowment. For example, extracting oil in Saudi Arabia and other Middle Eastern countries is essentially just a matter of drilling a hole. Producing oil in countries like the United States can require considerable exploration and costly technologies for drilling and extraction. This case of absolute advantage has been a key contributing factor towards much of the chaos in the Middle East. The United States and other countries will go to great extents to defend their oil interests, and will sometimes meddle in other country’s affairs in devastating ways.
Comparative Advantage
Let’s look further into these gains from trade.
hen Jamie decreased his production of pineapples from 50 to 40, he gained 8 crabs. This means his marginal cost was 0.8 crabs for 1 pineapple. W
The gains from trade arise from this difference in marginal cost. Since it is more expensive for Jamie to produce pineapples (MC of 0.8 versus your MC of 0.4) he should produce fewer pineapples and more crabs. The economic agent with the lower marginal cost of producing a good has the comparative advantage in producing that good. In this case, you have the comparative advantage in producing pineapples, and Jamie has the comparative advantage in producing crabs. This specialization in production results in gains from trade, as each person or country can focus on what it can produce at the lowest cost.
Note that even though Jamie had the absolute advantage in both goods, his marginal cost of producing crabs was still higher, since marginal cost is based on a trade-off between the two goods. We can liken this example to a trade between Canada and a developing country. Canada may be better at producing both computers and textiles (the absolute advantage) but the advantages we have in producing computers are far greate