Why Nations Trade

Why do nations trade?

• Because they have something to gain.• Because they have different terrains,

climates, and resources – means that some countries can produce some goods that others can not or that they can only produce at a very high cost.

Resource Distribution and Trade

• Each country of the world possesses different types and quantities of land, labor, and capital resources.

• By specializing in the production of certain goods and services, nations can use their resources more efficiently.

• Specialization and trade can benefit all nations.• Specialization is determined by a nation’s

natural resources and by its human and physical capital

Why Nations Trade

How do the nation’s factors of production determine the nation’s specialization?

1. Natural resources – help determine what goods and services an economy produces

2. Human capital – Measure literacy. A country with a high literacy rate is likely to have an education, skilled work force

3. Physical Capital – also includes public infrastructure (roads)

• Economic Activity Patterns – Producing– Exchanging– Consuming– Saving – Investing

• Geographic and human factors influence patterns of economic activity

Resource Distribution

The Need for Trade:• Specialization occurs when

producers- either individuals or nations – decide to produce only certain goods and services, rather than producing all the goods and services they need

• Specialization is determined by a nation’s natural resources and by its human and physical capital

• Examples: US produces wheat, soybeans, etc. We do not produce diamonds or coffee

Absolute and Comparative Advantage

• Absolute Advantage– Define: – Example:

• Comparative Advantage– Define:– Example:

• Law of Comparative Advantage– Define:

Absolute Advantage

• When a country has an absolute advantage over another country, it simply means that country can produce more of a good than another country.

• For example, Brazil has an absolute advantage over the United States in the production of sugar, while the United States has an absolute advantage over Brazil in the production of cars.

Comparative Advantage

• While large countries will probably have an absolute advantage in production over smaller countries, when any two countries are producing two goods (like cars and sugar), one country will always have a comparative advantage over the other in the production of one of the two goods. – The key to determining which country should produce

which good is opportunity cost• Put another way, given two countries that can both

produce sugar and cars, one country should specialize in producing cars and one country should specialize in producing sugar so that they can trade.

Absolute and Comparative Advantage

• A person or nation has an absolute advantage when it can produce more of a particular good than another person or nation.

• Comparative advantage is the ability of one person or nation to produce a good at a lower opportunity cost than that of another person or nation.

• The law of comparative advantage states that nations are better off when they produce goods and services for which they have a comparative advantage in supplying.

In this example, both Kate and Carlos benefit from specialization.

Specialization Trade Net Effect

Carl Kate

Specialization Trade Net Effect

Carl

KateCarl

Kate

Carl specializes, switching 2 hours from T-shirt production to birdhouse production.

Carl trades 1 birdhouse for 2 T-shirts.

Net effect is same number of T-shirts and 1 more birdhouse.

Kate specializes, switching 1 half- hour from birdhouse production to T-shirt production.

Carl trades 2 T-shirts for 1 birdhouse.

Net effect is same number of birdhouses and 1 more T-shirt.

Benefits from Specialization and Trade for Carl and Kate

Benefits of Trade

Benefits for Trade

• Both sides agree on a price that benefits both

• The nation that has the lower opportunity cost in producing a good has a comparative advantage in producing that good

• It is the nation with the comparative advantage- not necessarily the absolute advantage – that should specialize in producing that good

The United States is the world’s largest exporter.

The United States’ main trading partners are Canada, Mexico and Japan.

The United States is also the world’s largest importer.

Imports and Exports of the United States

TOP US TRADING PARTNERS JUNE 2011

• Canada• China• Mexico• Japan• Germany• United Kingdom• South Korea• Brazil• Netherlands• Taiwan

EXPORTS

• Goods produced within a country and sold to residents of a foreign country.

• Major U.S. exports:– Automobiles, computers, aircraft, corn, wheat,

soybeans, scientific instruments, coal, machinery, and plastic materials.

TOP US EXPORTS – JUNE 2011

• Civilian aircraft• Semiconductors• Passenger cars• Pharmaceutical preparations• Auto accessories• Other industrial machines• Fuel oil• Organic chemicals• Telecommunications• Plastic materials

IMPORTS

• Goods produced in a foreign country and purchased by the residents of a domestic country.

• Major U.S. imports:– Petroleum, clothing, iron, steel, office

machines, footwear, fish, coffee, and diamonds.

TOP US IMPORTS – JUNE 2011

• Crude oil• Passenger cars• Medicinal preparations• Auto accessories• Other household goods• Computer accessories• Petroleum products• Cotton apparel• Telecommunications equipment• Video equipment (dvd players)

TRADE DEFICIT

• U.S. buys more from the world than the world buys from it.

Trade and Employment

• Workers who lose their jobs due to specialization face three options:– Unemployment: Inability to adapt and find a new

job– Relocation: Moving to where current skills meet

current jobs– Retraining: Gaining new human capital to meet

the demands of specialized labor markets • As nations begin to specialize in certain goods,

dramatic changes in the nation’s employment patterns also occur.