UNIT

6 Macroeconomics

LESSON 1

International Trade Introduction and Description This lesson includes a review of comparative advantage and production possibilities curves. It then expands the concepts of specialization and trade to show the gains from international trade. Activity 49 gives the students practice in determining comparative advantage using either the input or output method of presenting the information. In Activity 50, the students determine who has comparative advantage, explain the reasons behind their decision and then show the gains from trade when given the terms of trade.

Objectives 1. Define comparative advantage, terms of trade and gains from trade. 2. Explain comparative advantage using opportunity costs. 3. Demonstrate that specialization and trade allow consumption possibilities to exceed production possibilities. 4. Determine the terms of trade.

Time Required One class period or 45 minutes

Materials 1. Activities 49 and 50 2. Visuals 6.1 and 6.2

Procedure 1. Project Visual 6.1 and work through the comparative advantage problem. 2. Project Visual 6.2, which shows the production possibilities curves for Israel and the United States as indicated on Visual 6.1. Answer the questions on Visual 6.1. (A) For the United States, the opportunity cost of producing one bushel of oranges is two

bushels of avocadoes. For Israel, the opportunity cost of producing one bushel of oranges is four bushels of avocadoes. Thus, it is cheaper in terms of avocadoes for the United States to produce oranges. The United States has the comparative advantage in producing oranges. (B) For the United States, the opportunity cost of producing one bushel of avocadoes is one-half a bushel of oranges. For Israel, the opportunity cost of producing one bushel of avocadoes is one-fourth of a bushel of oranges. Thus, it is cheaper in terms of oranges for Israel to produce avocadoes. Israel has the comparative advantage in producing avocadoes. 3. Explain that the terms of trade are expressed in terms of the commodities to be exchanged. For each country there is a range of acceptable terms of trade. The United States is willing to trade one bushel of oranges for two or more bushels of avocadoes; Israel is willing to trade one bushel of oranges for less than four bushels of avocadoes. Thus, both the United States and Israel would be willing to trade one bushel of oranges for three bushels of avocadoes. Both countries gain from the trade. 4. Explain that before specialization and trade, the United States was producing 50 bushels of oranges and 50 bushels of avocadoes: Point A on Visual 6.2. If, after specialization and trade, the United States wants to continue to have 50 bushels of oranges — and the terms of trade are one bushel of oranges for three bushels of avocadoes — then the United States could trade 25 bushels of oranges for 75 bushels of avocadoes. Note that this combination — 50 bushels of oranges and 75 bushels of avocadoes — puts the United States outside of its production possibilities curve as indicated as point A' on the PPC in Visual 6.2.

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UNIT

6 Macroeconomics Similarly, Israel would have 25 bushels of oranges and 325 bushels of avocadoes: Point B' after specialization and trade on the PPC in Visual 6.2. Note: (A) Had Israel produced 25 bushels of oranges before specialization and trade, it would have had only 300 bushels of avocadoes (Point B on PPC in Visual 6.2). (B) The combination of 25 bushels of oranges and 325 bushels of avocadoes (B') puts Israel outside of its production possibilities curve. Thus, the United States has gained 25 bushels of avocadoes, and Israel has gained 25 bushels of avocadoes.

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LESSON 1 5. Emphasize: (A) The terms of trade can be anywhere between one bushel of oranges for two to four bushels of avocadoes. The actual terms of trade are based on market prices that reflect the opportunity costs. (B) There is a wide range of solutions depending on the agreed-to terms of trade and the willingness to trade specific amounts of the commodities. 6. Have the students complete Activity 49 in class. Review the answers with the students. 7. The students should complete Activity 50 for homework. Review the answers with the students.

Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 49

Answer Key

Determining Comparative Advantage Part A Productivity Measures and Example Problems Output Method Tons Produced per Hour Fish (A) Cheese (B) Ted

60

25

Nancy

45

40

For Ted, the opportunity cost of producing fish in terms of cheese is 60 fish = 25 cheese; therefore 1 fish =  ⁄ cheese. On the other hand, 1 cheese = ¹ ⁄ fish. Similarly we can calculate the opportunity costs for Nancy. We summarize the opportunity cost information in the table below. Opportunity Cost (B / A) Fish Ted Nancy

5/12 8/9

Opportunity Cost (A / B) Cheese

(0.42) cheese

12/5

(0.89) cheese

9/8

(2.4)

fish

(1.125) fish

Ted should produce fish because his opportunity cost in terms of cheese is less than Nancy’s opportunity cost. Nancy should produce cheese because her opportunity cost in terms of fish is less than Ted’s opportunity cost to produce cheese. Ted producing fish and Nancy producing cheese yields the most fish and cheese per hour of any combination of production.

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UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 49

Answer Key

Input Method Acres Required to Produce One Bushel Apples (A) Pears (B) Tony

5

2

Chris

6

3

For the input method, the opportunity cost of producing one apple in terms of pears requires that we initially convert the input (acres) into output. For Tony, 5 acres = 1 apple; therefore, 1 acre = ¹⁄ apple. Also 2 acres = 1 pear; therefore, 1 acre = ¹⁄ pear. Now you can use the same method as for the output method: ¹⁄ apple = ¹⁄ pear; therefore 1 apple = ⁄ pear. Likewise 1 pear = ⁄ apple. We summarize the opportunity costs in the following table. Opportunity Cost (B / A) Apples Tony

5/2

(2.5) pears

Chris

6/3 (2)

pears

Opportunity Cost (A / B) Pears 2/5

(0.40) apples

3/6

(0.50) apples

Tony has the comparative advantage in producing pears. To produce one bushel of pears, Tony must give up 0.40 bushels of apples, whereas Chris has to give up half (0.50) of a bushel of apples. Thus, the opportunity cost of a bushel of pears is lower for Tony than for Chris, and so Tony should produce pears. Conversely, Chris should produce apples because he has the lower opportunity cost in terms of forgone bushels of pears.

Part B Practice Problems First decide whether the problem is an output or input problem; underline output or input. Then in the space below the table, calculate the opportunity cost of each product and indicate the product with the lower opportunity cost for each person, firm or country. The first one is completed for you. 1. Anna and Barry can grow the following amounts of potatoes and cabbage with the same amount of labor. Type of problem: (output / input) Potatoes

Cabbage

Anna

100

200

Barry

120

150

For Anna, the opportunity cost of one potato is two cabbages; for Barry, the opportunity cost of one potato is 1.25 cabbages. Barry has to give up fewer cabbages than does Anna to grow one potato. Thus, the opportunity cost of potatoes is lower for Barry than for Anna, so Barry should grow potatoes. Conversely, to grow one cabbage, Anna must give up one-half potato and Barry must give up 0.80 potato. Thus, the opportunity cost of growing cabbages is lower for Anna than it is for Barry, so Anna should grow cabbages.

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Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 49

Answer Key

2. Number caught per day. Type of problem: (output / input) Deer

Antelope

Henry

4

6

John

24

12

For Henry, the opportunity cost of one deer is 1.5 antelopes. For John the opportunity cost of one deer is 0.5 antelope. Conversely, for Henry the opportunity cost of one antelope is 2/3 of a deer. For John the opportunity cost of one antelope is two deer. John should hunt deer, and Henry should hunt antelope.

3. Days to produce one unit of each. Type of problem: (output / input) Cars

Planes

8

10

15

12

XYZ Corp. QKFX Corp.

It takes XYZ Corp. eight days to produce a car and 10 days to produce a plane. Therefore, XYZ Corp.’s opportunity cost for one car is 0.8 plane. QKFX Corp.’s opportunity cost for a car is 1.25 planes. XYZ Corp.’s opportunity cost for producing one plane is 1.25 cars. QKFX Corp.’s opportunity cost of producing one plane is 0.8 car. XYZ Corp. should produce cars, and QKFX Corp. should produce planes.

4. Acres to produce 100 bushels. Type of problem: (output / input) Corn

Rice

India

9

3

China

8

2

On one acre of land, India can produce 100/9 (11.11) bushels of corn or 100/3 (33.33) bushels of rice. The opportunity cost of one bushel of corn is three bushels of rice; or, alternatively, the opportunity cost of one bushel of rice is 1/3 of a bushel of corn. On one acre of land, China can produce 100/8 (12.5) bushels of corn or 100/2 (50) bushels of rice. The opportunity cost of one bushel of corn is four bushels of rice, and the opportunity cost of one bushel of rice is 1/4 bushel of corn. Therefore, India has a comparative advantage in the production of corn and should produce corn, whereas China should produce rice.

Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.

645

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 49

Answer Key

5. To produce the following from one ton of olives. Type of problem: (output / input) Cans of Olives

Bottles of Olive Oil

Zaire

60

10

Colombia

24

8

For Zaire, the opportunity cost of a can of olives is 1/6 of a bottle of olive oil. For Colombia, the opportunity cost of a can of olives is 1/3 of a bottle of olive oil. Conversely, for Zaire the opportunity cost of a bottle of olive oil is six cans of olives. For Colombia, the opportunity cost of a bottle of olive oil is three cans of olives. Zaire should produce cans of olives, and Colombia should produce bottles of olive oil.

6. Why should a person, firm or country produce the product that has the lower opportunity cost and trade for the other product? Specializing in the product that has the lower opportunity cost produces more products than any other combination of production.

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Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 50

Answer Key

Economic Efficiency and Gains from Trade Underline the correct words in parentheses and complete the questions. 1. The following table gives the number of hours it takes in the United States and Scotland, using the same amount of resources, to produce a ton of oats or one bagpipe. Oats

Bagpipe

United States

3 hours

2 hours

Scotland

4 hours

5 hours

(A) (The United States / Scotland) has an absolute advantage in the production of oats. (B) (The United States / Scotland) has an absolute advantage in the production of bagpipes. (C) (The United States / Scotland) has a comparative advantage in the production of oats because Scotland has a lower opportunity cost to produce oats in terms of bagpipes than the United States.

(D) (The United States / Scotland) has a comparative advantage in the production of bagpipes because the United States has a lower opportunity cost to produce bagpipes in terms of oats than does Scotland.

(E) Based only on the data above and comparative advantage considerations, the United States should specialize in (oats / bagpipes). (F) Based only on the data above and comparative advantage considerations, Scotland should specialize in (oats / bagpipes). (G) Why will both Scotland and the United States be better off if they specialize and trade? Total output will be greater using the same resources and trading.

(H) Suppose that Scotland and the United States agree to specialize according to comparative advantage and to the following terms of trade: one ton of oats for one bagpipe. In a production period there are 60 hours, and before specialization Scotland produced 7.5 tons of oats and six bagpipes. After specialization and trade with the United States, Scotland wants to maintain the six bagpipes. How many tons of oats will it have? What are its gains from trade? Scotland will have six bagpipes and nine tons of oats. Its gains from trade are 1.5 tons of oats.

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647

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 50

Answer Key

2. The following table gives the number of hours it takes in the United States and Canada, using the same amount of resources, to produce a ton of wheat or one bolt of cloth. Wheat

Cloth

United States

1 hour

2 hours

Canada

3 hours

4 hours

(A) (The United States / Canada) has an absolute advantage in the production of wheat. (B) (The United States / Canada) has an absolute advantage in the production of cloth. (C) (The United States / Canada) has a comparative advantage in the production of wheat because the opportunity cost of producing wheat is less than for Canada.

(D) (The United States / Canada) has a comparative advantage in the production of cloth because the opportunity cost of producing cloth is less than for the United States.

(E) Based only on the data above and comparative advantage considerations, the United States should specialize in (wheat / cloth). (F) Based only on the data above and comparative advantage considerations, Canada should specialize in (wheat / cloth). (G) Why will both Canada and the United States be better off if they specialize and trade? Using the same resources, total output will be greater.

(H) Suppose that Canada and the United States agree to specialize according to comparative advantage and to the following terms of trade: three tons of wheat for two bolts of cloth. In a production period, there are 60 hours; and before specialization, Canada produced nine tons of wheat and 8.25 bolts of cloth. After specialization and trade with the United States, Canada wants to maintain the nine tons of wheat for each production period. How many bolts of cloth will it have? What are its gains from trade? Canada initially produces 15 bolts of cloth; it will trade six bolts of cloth for nine tons of wheat. Canada will have nine bolts of cloth. It will gain .75 bolts of cloth from specialization and trade.

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Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.

UNIT

6 Macroeconomics

LESSON 1 ■ ACTIVITY 50

Answer Key

3. The following table gives the number of hours it takes in the United States and Japan, using the same amount of resources, to produce one computer or one auto. Computer

Auto

United States

2 hours

5 hours

Japan

1 hour

4 hours

(A) (The United States / Japan) has an absolute advantage in the production of computers. (B) (The United States / Japan) has an absolute advantage in the production of autos. (C) (The United States / Japan) has a comparative advantage in the production of computers because the opportunity cost is less than for the United States.

(D) (The United States / Japan) has a comparative advantage in the production of autos because the opportunity cost is less than for Japan.

(E) Based only on the data above and comparative advantage considerations, the United States should specialize in (computers / autos). (F) Based only on the data above and comparative advantage considerations, Japan should specialize in (computers / autos). (G) Why will both Japan and the United States be better off if they specialize and trade? More automobiles and computers will be produced from the same resources.

(H) Suppose that Japan and the United States agree to specialize according to comparative advantage and to the following terms of trade: three computers for one auto. In a production period there are 60 hours; and before specialization, Japan produced 40 computers and five autos. After specialization and trade with the United States, Japan wants to maintain the five autos for each production period. How many computers will it have? What are its gains from trade? Japan will produce 60 computers in 60 hours; it will trade 15 computers to receive five automobiles. Japan will have 45 computers. Its gains from trade are five computers.

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