Part 1Trade

Trading with the World
(1 of 2)

1. Review

Have you any questions on the previous lesson, homework, or materials listed on the previous daily class outline?

2. Course Objectives The first three course objectives from Macroeconomics text page 441 or from Microeconomics text page 473 are :

1. Describe the patterns in international trade.

2. Explain comparative advantage and explain why all countries can gain from international trade.

3. Explain how economies of scale and diversity of taste lead to gains from trade.

3. Optional Economic Activity - The French Wheat and German Steel Problem

Your instructor may present a model that demonstrates the potential for two nations to produce and to consume beyond their respective production possibility frontiers.

4. Outline

I. Patterns and Trends in International Trade

A. Imports are goods and services produced abroad and bought in our country; exports are goods and services we produce and sell to people in other countries.

1. About 74 percent of our exports and 83 percent of our imports is in goods. The remainder is in services.

2. Manufactured goods account for 50 percent of our exports and 60 percent of our imports. Industrial supplies (17 percent of exports, 20 percent of imports) and agricultural products (7 percent of exports, 3 percent of imports) are other big categories of trade.

B. The United States trades with almost all parts of the world. The biggest single trading partner is Canada. About 45 percent of U.S. imports come from Asian nations.

C. Imports and exports have become an increasingly large part of U.S. output. In 1960, imports and exports were each about 5 percent of total output; they have doubled in recent years.

D. The balance of trade equals the value of exports minus the value of imports, In 1996, the U.S. balance of trade was –$95 billion (negative $95 billion) so that more goods and services were imported than exported.

II. Opportunity Cost and Comparative Advantage

A. The opportunity cost of a good in terms of another good is given by the slope of the production possibility frontier, or PPF.

B. A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country.

C. Nations engaged in international trade gain when they can buy goods at lower opportunity costs abroad than they can produce the goods domestically, that is, when they can buy the goods for a lower relative price than it costs to produce them.

1. Countries tend to specialize in producing goods in which they have a comparative advantage.

2. By producing according to comparative advantage and engaging in trade, countries can consume combinations of goods that lie beyond their PPF. Because consumption can occur beyond the boundary of the PPF, all countries can gain from international trade.

D. The principles just outlined are demonstrated in the text with an example of trade between "Farmland" and "Mobilia." The opportunity cost of a car (slope of the PPF) in Farmland is 9,000 bushels of grain, and in Mobilia it is 1,000 bushels. Hence Mobilia exports cars to Farmland, and Farmland exports grain to Mobilia. Both Mobilia and Farmland gain because both can consume at a point that is beyond their PPF.

III. Gains from Trade in Reality

A. Countries trade similar goods; that is, automobiles are both exported from the United States and imported into the United States. This trade occurs because of the interaction of two factors:

1. People have diverse tastes. Thus a large number of goods are similar but not identical, such as compact cars versus performance cars.

2. Economies of scale (when the average cost of production falls as the level of production increases) may lead producers in different countries to use the export market in order to sell output (of a diverse product) world-wide and thereby capture economies of scale.

5. PowerPoint Viewgraphs (Slides 1 - 10, 11- 35, and 36 - 38)

Do thetrue or false, multiple choice, and problems associated with:

Patterns and Trends in International Trade;

Opportunity Cost and Comparative Advantage;

Gains From Trade.

1. Review study guide Key Concepts in Microeconomics page 363 - 365 or in Macroeconomics page 283-285.
2. Complete the odd-numbered Questions from your study guide and check your answers.
3. Compare your class notes and your understanding of the homework Questions with your study partner.

1. Large flows of trade take place between countries, most of which is in manufactured goods.

2. Since 1960, the volume of U.S. trade, as a percentage of total output, has more than doubled.

Opportunity Cost and Comparative Advantage

3. When opportunity costs between countries diverge, comparative advantage enables countries to gain from international trade.

Gains from Trade

4. By increasing its production of goods in which it has a comparative advantage and then trading some of the increased output, a country can consume at a point outside its production possibility curve.

5. In the absence of international borrowing and lending, trade is balanced as prices adjust to reflect the international supply of and demand for goods.

6. The world price balances the production and consumption plans of the trading parties. At the equilibrium price, trade is balanced.

Gains from Trade in Reality

7. Comparative advantage explains the international trade that takes place in the world.

8. But trade in similar goods arises from economies of scale in the face of diversified tastes.

file: Week 04 Part 1

Notes

2. Economies of scale (when the average cost of production falls as the level of production increases) may lead producers in different countries to use the export market in order to sell output (of a diverse product) world-wide and thereby capture economies of scale.

For Use in
Principles of Economics I (Macroeconomics) &
Principles of Economics II (Microeconomics)

3. Optional Economic Activity - The French Wheat and German Steel Problem

Your instructor may present a model that demonstrates the potential for two nations to produce and to consume beyond their respective production possibility frontiers.

I. Patterns and Trends in International Trade

A. Imports are goods and services produced abroad and bought in our country; exports are goods and services we produce and sell to people in other countries.

1. About 74 percent of our exports and 83 percent of our imports is in goods. The remainder is in services.

2. Manufactured goods account for 50 percent of our exports and 60 percent of our imports. Industrial supplies (17 percent of exports, 20 percent of imports) and agricultural products (7 percent of exports, 3 percent of imports) are other big categories of trade.

B. The United States trades with almost all parts of the world. The biggest single trading partner is Canada. About 45 percent of U.S. imports come from Asian nations.

C. Imports and exports have become an increasingly large part of U.S. output. In 1960, imports and exports were each about 5 percent of total output; they have doubled in recent years.

D. The balance of trade equals the value of exports minus the value of imports, In 1996, the U.S. balance of trade was –$95 billion (negative $95 billion) so that more goods and services were imported than exported.

II. Opportunity Cost and Comparative Advantage

A. The opportunity cost of a good in terms of another good is given by the slope of the production possibility frontier, or PPF.

B. A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country.

C. Nations engaged in international trade gain when they can buy goods at lower opportunity costs abroad than they can produce the goods domestically, that is, when they can buy the goods for a lower relative price than it costs to produce them.

1. Countries tend to specialize in producing goods in which they have a comparative advantage.

2. By producing according to comparative advantage and engaging in trade, countries can consume combinations of goods that lie beyond their PPF. Because consumption can occur beyond the boundary of the PPF, all countries can gain from international trade.

III. Gains from Trade in Reality

A. Countries trade similar goods; that is, automobiles are both exported from the United States and imported into the United States. This trade occurs because of the interaction of two factors:

1. People have diverse tastes. Thus a large number of goods are similar but not identical, such as compact cars versus performance cars.

Gains from Trade in Reality

7. Comparative advantage explains the international trade that takes place in the world.

8. But trade in similar goods arises from economies of scale in the face of diversified tastes.

file: Week 04 Part 1

For Use in Principles of Economics I (Macroeconomics) & Principles of Economics II (Microeconomics)

3. Optional Economic Activity - The French Wheat and German Steel Problem Your instructor may present a model that demonstrates the potential for two nations to produce and to consume beyond their respective production possibility frontiers.

I. Patterns and Trends in International Trade

A. Imports are goods and services produced abroad and bought in our country; exports are goods and services we produce and sell to people in other countries.

1. About 74 percent of our exports and 83 percent of our imports is in goods. The remainder is in services.

2. Manufactured goods account for 50 percent of our exports and 60 percent of our imports. Industrial supplies (17 percent of exports, 20 percent of imports) and agricultural products (7 percent of exports, 3 percent of imports) are other big categories of trade.

B. The United States trades with almost all parts of the world. The biggest single trading partner is Canada. About 45 percent of U.S. imports come from Asian nations.

C. Imports and exports have become an increasingly large part of U.S. output. In 1960, imports and exports were each about 5 percent of total output; they have doubled in recent years.

D. The balance of trade equals the value of exports minus the value of imports, In 1996, the U.S. balance of trade was –$95 billion (negative $95 billion) so that more goods and services were imported than exported.

II. Opportunity Cost and Comparative Advantage

A. The opportunity cost of a good in terms of another good is given by the slope of the production possibility frontier, or PPF.

B. A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country.

C. Nations engaged in international trade gain when they can buy goods at lower opportunity costs abroad than they can produce the goods domestically, that is, when they can buy the goods for a lower relative price than it costs to produce them.

1. Countries tend to specialize in producing goods in which they have a comparative advantage.

2. By producing according to comparative advantage and engaging in trade, countries can consume combinations of goods that lie beyond their PPF. Because consumption can occur beyond the boundary of the PPF, all countries can gain from international trade.

III. Gains from Trade in Reality

A. Countries trade similar goods; that is, automobiles are both exported from the United States and imported into the United States. This trade occurs because of the interaction of two factors:

1. People have diverse tastes. Thus a large number of goods are similar but not identical, such as compact cars versus performance cars.

2. Economies of scale (when the average cost of production falls as the level of production increases) may lead producers in different countries to use the export market in order to sell output (of a diverse product) world-wide and thereby capture economies of scale.

Gains from Trade in Reality

7. Comparative advantage explains the international trade that takes place in the world. 8. But trade in similar goods arises from economies of scale in the face of diversified tastes. file: Week 04 Part 1

For Use in
Principles of Economics I (Macroeconomics) &
Principles of Economics II (Microeconomics)

3. Optional Economic Activity - The French Wheat and German Steel Problem

Your instructor may present a model that demonstrates the potential for two nations to produce and to consume beyond their respective production possibility frontiers.

7. Comparative advantage explains the international trade that takes place in the world.

8. But trade in similar goods arises from economies of scale in the face of diversified tastes.

file: Week 04 Part 1