Post by Gelare on Jul 10, 2008 18:11:07 GMT -5
International Trade
"Who are these guys, and why do they talk funny?"
Welcome, students, to today's lecture in Economics 101 - Survey of Economics. I am, as ever, your humble Dean Gelare, here to teach you a bit about international trade. Trade between nations plays a significant part in today's world, fueling both the Middle East's vast accumulation of wealth from their oil reserves and China's rapid expansion, to name just a few instances. Feel free to discuss this lecture in the associated discussion thread.
A Reason For Trade
"Bah, who needs 'em?"
International relations have been an important issue since before trade boats ever crossed the Mediterranean thousands of years ago, but really, who needs all that drama? Ambassadors, wars, treaties, tariffs, it all seems like more trouble than it's worth. We can be isolationists instead! Cut off our ties to other countries, be our own island, totally self-sufficient. That's totally possible to do. Let's assume we have a good mix of land, capital, labor, materials, and then sure, we could definitely produce everything we need right here at home.
Having The Advantage
"It seems I've gained the upper hand.
Let's say that, as a country, we can collectively muster 100 hours of labor per day. And the central planner, say, me, can allocate those hours as he sees fit between producing two goods, food and clothing. Because of the unique features of Uantir - the rolling fields, the verdant forests, and so forth - it takes us only one hour of labor to produce a bushel of crops, but two hours to produce a bolt of cloth. So we could produce one hundred units of food, or fifty units of clothing, or anything in between. Now, you can't eat clothing, and you can't wear food (except while very drunk), so it seems reasonable to say that we'd want a good mix. Let's say we decide to make 30 bits of clothing and 40 pieces of food per day. 30 clothes x 2 hours per clothing + 40 food x 1 hour per food = 60 + 40 = 100 total labor hours, which is all of our production capacity. And we're fairly happy with our food and clothing. Everything's good.
Now, let's say we have two neighbors to our north and south. The one up north has similar production ability to ours, with 100 hours of available labor each day, but because of their natural resources, they have an easier time making textiles and a harder time growing crops; it takes them one hour to produce a unit of clothing and two hours to make a unit of food. Before trade, we'll say they're making 40 clothes and 30 food, the reverse of us. We'll call them Canada. One day the Canadian ambassador comes to Castle Uantir and requests that we open our borders to trade with their country. What should we do?
As stated, it takes us two hours to produce clothes, but only one hour to produce food, while Canada can produce clothing in one hour, but food in two. In trade terms, we have an absolute advantage over Canada in producing food, since we can do it with less labor. Similarly, they have an absolute advantage in the production of clothing, since they can do that in less time than we can. There's another concept here, the importance of which will be demonstrated later, called comparative advantage. Since we have to give up two units of food (two hours) to produce one unit of clothing (also two hours), whereas Canada has to give up half a unit of food (one of their hours) for one unit of clothing (again, only one of their hours because of the different production technology), we say that Canada has a comparative advantage in the production of clothing - they have to give up less food to make clothing than we do. Similarly, we have a comparative advantage in the production of food.
Now, we could open to trade, and they'd give us five of their clothes for five of our food; we'd each have 35 food and 35 clothing, and we'd all be happier. This looks like a good thing, and it is. But I submit to you we can do even better.
Specialization
"I can perform brain surgery and you can't; that's why I've got M.D. after my name."
Since Uantir is so good at agriculture, I'm going to say we should shift all our production to food. We now generate 100 units of food per day, since we start with 100 units of labor, and it takes us one hour for each unit of food we want. Meanwhile, the Canadian ambassador returns to his country with the news that there are great profits to be made if his country specializes in textiles; they now make 100 units of clothes per day. Free trade happens, and like magic, Uantir and Canada now each have fifty units of food and fifty units of clothes, way better off than we each were doing on our own. It looks like we can indeed benefit from trade, and should open our borders to trade with Canada.
Next case, to the south we have another neighbor that is less technologically advanced than us. They still have 100 units of labor to allocate per day, but they're not as good at making stuff. It takes them two and a half hours to make a unit of food, and a whopping ten hours to produce a unit of clothing. We'll call them Mexico. On their own, they make eight units of each food and clothing, but now they want to trade with us. Should we let them?
In this model, Uantir has an absolute advantage in the production of both food and clothes - no matter what we're making, we're just better at it. We also have a comparative advantage in the production of clothing, because we can always give up two units of food for one unit of clothes, whereas Mexico would have to give up four units of food to free up the ten hours of labor they need to make clothes. Naturally, this means Mexico has a comparative advantage in the production of food. Now what?
If we open to trade, Mexico can specialize in the good it has a comparative advantage in, food, and make 40 units of food per day. Meanwhile, we can shift most of our production to clothing, making 45 units of clothing and 10 units of food. We do some trade, and we end up with 40 food and 35 clothes, which is better than the 40 food and 30 clothes we could make by ourselves, while Mexico keeps 10 units of food and gets ten units of clothes, an improvement over the eight units of each they used to have.
Everybody Wins
"Except for that guy, right there. He loses."
So we see that even when one country has an absolute advantage in the production of everything, it's still to that country's benefit to open to trade, because, and this is important, in this Ricardian model, gains from trade come from comparative, not absolute, advantages. Your mind should have just been blown.
This model is called Ricardian because the famous economist, David Ricardo, came up with it in the early 19th century in order to convince the British parliament to open up to free trade. It's win-win! Both countries are better off! Strictly better, all the time!
What David Ricardo swept under the rug is that everyone in an economy is not the same, and while the economy in the aggregate will benefit from opening to trade, some people are going to be very unhappy with it. Notice, in the Canada example we shut down all the clothing factories, which put anyone who worked there out of a job (until they could relocate and retrain to be in the agricultural sector), and the factory owners would just be totally screwed. Meanwhile, in the Mexico example, we razed a bunch of farms to make room for textile factories, which is very sad for the farmers and the rolling plains of Uantir.
So is international trade a good thing? Should the U.S. let China flood their markets with cheap textiles, or should they impose tariffs on foreign cars to keep Ford and General Motors afloat? (If any of you own stock in either of those companies, you have my sympathy.) Feel free to discuss in the thread.
"Who are these guys, and why do they talk funny?"
Welcome, students, to today's lecture in Economics 101 - Survey of Economics. I am, as ever, your humble Dean Gelare, here to teach you a bit about international trade. Trade between nations plays a significant part in today's world, fueling both the Middle East's vast accumulation of wealth from their oil reserves and China's rapid expansion, to name just a few instances. Feel free to discuss this lecture in the associated discussion thread.
A Reason For Trade
"Bah, who needs 'em?"
International relations have been an important issue since before trade boats ever crossed the Mediterranean thousands of years ago, but really, who needs all that drama? Ambassadors, wars, treaties, tariffs, it all seems like more trouble than it's worth. We can be isolationists instead! Cut off our ties to other countries, be our own island, totally self-sufficient. That's totally possible to do. Let's assume we have a good mix of land, capital, labor, materials, and then sure, we could definitely produce everything we need right here at home.
Having The Advantage
"It seems I've gained the upper hand.
Let's say that, as a country, we can collectively muster 100 hours of labor per day. And the central planner, say, me, can allocate those hours as he sees fit between producing two goods, food and clothing. Because of the unique features of Uantir - the rolling fields, the verdant forests, and so forth - it takes us only one hour of labor to produce a bushel of crops, but two hours to produce a bolt of cloth. So we could produce one hundred units of food, or fifty units of clothing, or anything in between. Now, you can't eat clothing, and you can't wear food (except while very drunk), so it seems reasonable to say that we'd want a good mix. Let's say we decide to make 30 bits of clothing and 40 pieces of food per day. 30 clothes x 2 hours per clothing + 40 food x 1 hour per food = 60 + 40 = 100 total labor hours, which is all of our production capacity. And we're fairly happy with our food and clothing. Everything's good.
Now, let's say we have two neighbors to our north and south. The one up north has similar production ability to ours, with 100 hours of available labor each day, but because of their natural resources, they have an easier time making textiles and a harder time growing crops; it takes them one hour to produce a unit of clothing and two hours to make a unit of food. Before trade, we'll say they're making 40 clothes and 30 food, the reverse of us. We'll call them Canada. One day the Canadian ambassador comes to Castle Uantir and requests that we open our borders to trade with their country. What should we do?
As stated, it takes us two hours to produce clothes, but only one hour to produce food, while Canada can produce clothing in one hour, but food in two. In trade terms, we have an absolute advantage over Canada in producing food, since we can do it with less labor. Similarly, they have an absolute advantage in the production of clothing, since they can do that in less time than we can. There's another concept here, the importance of which will be demonstrated later, called comparative advantage. Since we have to give up two units of food (two hours) to produce one unit of clothing (also two hours), whereas Canada has to give up half a unit of food (one of their hours) for one unit of clothing (again, only one of their hours because of the different production technology), we say that Canada has a comparative advantage in the production of clothing - they have to give up less food to make clothing than we do. Similarly, we have a comparative advantage in the production of food.
Now, we could open to trade, and they'd give us five of their clothes for five of our food; we'd each have 35 food and 35 clothing, and we'd all be happier. This looks like a good thing, and it is. But I submit to you we can do even better.
Specialization
"I can perform brain surgery and you can't; that's why I've got M.D. after my name."
Since Uantir is so good at agriculture, I'm going to say we should shift all our production to food. We now generate 100 units of food per day, since we start with 100 units of labor, and it takes us one hour for each unit of food we want. Meanwhile, the Canadian ambassador returns to his country with the news that there are great profits to be made if his country specializes in textiles; they now make 100 units of clothes per day. Free trade happens, and like magic, Uantir and Canada now each have fifty units of food and fifty units of clothes, way better off than we each were doing on our own. It looks like we can indeed benefit from trade, and should open our borders to trade with Canada.
Next case, to the south we have another neighbor that is less technologically advanced than us. They still have 100 units of labor to allocate per day, but they're not as good at making stuff. It takes them two and a half hours to make a unit of food, and a whopping ten hours to produce a unit of clothing. We'll call them Mexico. On their own, they make eight units of each food and clothing, but now they want to trade with us. Should we let them?
In this model, Uantir has an absolute advantage in the production of both food and clothes - no matter what we're making, we're just better at it. We also have a comparative advantage in the production of clothing, because we can always give up two units of food for one unit of clothes, whereas Mexico would have to give up four units of food to free up the ten hours of labor they need to make clothes. Naturally, this means Mexico has a comparative advantage in the production of food. Now what?
If we open to trade, Mexico can specialize in the good it has a comparative advantage in, food, and make 40 units of food per day. Meanwhile, we can shift most of our production to clothing, making 45 units of clothing and 10 units of food. We do some trade, and we end up with 40 food and 35 clothes, which is better than the 40 food and 30 clothes we could make by ourselves, while Mexico keeps 10 units of food and gets ten units of clothes, an improvement over the eight units of each they used to have.
Everybody Wins
"Except for that guy, right there. He loses."
So we see that even when one country has an absolute advantage in the production of everything, it's still to that country's benefit to open to trade, because, and this is important, in this Ricardian model, gains from trade come from comparative, not absolute, advantages. Your mind should have just been blown.
This model is called Ricardian because the famous economist, David Ricardo, came up with it in the early 19th century in order to convince the British parliament to open up to free trade. It's win-win! Both countries are better off! Strictly better, all the time!
What David Ricardo swept under the rug is that everyone in an economy is not the same, and while the economy in the aggregate will benefit from opening to trade, some people are going to be very unhappy with it. Notice, in the Canada example we shut down all the clothing factories, which put anyone who worked there out of a job (until they could relocate and retrain to be in the agricultural sector), and the factory owners would just be totally screwed. Meanwhile, in the Mexico example, we razed a bunch of farms to make room for textile factories, which is very sad for the farmers and the rolling plains of Uantir.
So is international trade a good thing? Should the U.S. let China flood their markets with cheap textiles, or should they impose tariffs on foreign cars to keep Ford and General Motors afloat? (If any of you own stock in either of those companies, you have my sympathy.) Feel free to discuss in the thread.