Gains from Trade
Introduction
Definition of Economic Interdependence
Economic interdependence refers to the reciprocal relationship between various economic entities where their respective well-being is mutually dependent.
Definition of Specialization
Specialization is the concentration of productive capabilities in a particular area, trade, skill, or set of tasks.
Economic Theory
Opportunity Cost
Definition
Opportunity cost refers to the value of the next best alternative that is foregone when a choice is made.
Application to Specialization
When an entity specializes, it may give up the opportunity to produce something else, aiming to produce what it's best at.
Comparative Advantage
Comparative advantage is a principle that suggests that entities gain more from trade if they specialize in the production of goods and services in which they are relatively more efficient.
The Role of Assumptions
In economic theory, assumptions are often made to simplify complex systems and make them easier to understand or model.
Modeling Economic Behavior
Economists use various models to predict and explain how entities interact in a specialized and interdependent economy.
Benefits of Specialization
Highlights
- Efficiency increases as entities focus on what they are best at.
- Quality of output generally improves with specialization.
- Greater output can be achieved when specialized skills are utilized.
- Specialization often leads to innovation as entities strive for a competitive edge.
Case Studies
Countries
USA and China
The USA specializes in high-tech and service sectors, whereas China specializes in manufacturing.
Japan and Brazil
Japan is specialized in high-tech industries, while Brazil is specialized in agricultural exports.
Individual Specialization
Surgeons vs. General Practitioners
Surgeons are specialized in specific surgical procedures, providing highly skilled service, whereas general practitioners offer a broader range of medical services.
Software Engineers and Hardware Engineers
Software engineers focus on writing code, while hardware engineers focus on physical components.
Comparative Advantage
Comparative advantage is the ability to perform a task at a lower opportunity cost than someone else.
David Ricardo's Theory
David Ricardo, in 1817, introduced the theory of comparative advantage.
Ricardo's Argument Against Corn Laws
Ricardo argued against tariffs on imported grain, which was beneficial for landowners but detrimental for factory workers.
Opportunity Costs of Selkirk and Pirate Jack
Calculation for Selkirk
Selkirk's opportunity cost for gathering turnips is 1 clam, and for clams, it's 1 turnip.
Calculation for Pirate Jack
Pirate Jack's opportunity cost for gathering turnips is 0.5 clams, and for clams, it's 2 turnips.
Comparative Advantage in Practice
Selkirk's Comparative Advantage
Selkirk has a lower opportunity cost for digging clams, giving him a comparative advantage in clam digging.
Pirate Jack's Comparative Advantage
Pirate Jack has a lower opportunity cost for gathering turnips, giving him a comparative advantage in turnip gathering.
Specialization and Trade
Theoretical and Practical Gains
According to Ricardo's theory, both would benefit from specializing in what they have a comparative advantage in, and then trading. By trading 17 clams for 25 turnips, both men end up with more food than they would have had if they worked alone.
The Principle of Comparative Advantage
- Definition: Specializing in what one is comparatively better at for mutual benefits.
- Benefits all trading partners, even those without absolute advantages.
Factors Contributing to Comparative Advantage
Natural Resources and Geography
- Florida excels in orange production due to warm climate.
- Idaho specializes in potato farming.
- Nevada has gold deposits, leading to a focus on gold mining.
- Saudi Arabia has abundant oil reserves.
Human Capital and Skill Levels
- Highly skilled workforce gives the U.S. an edge in high-tech industries.
- Less developed nations may specialize in labor-intensive, low-skill work like clothing production.
Technological Advances
- Advanced technology can confer a comparative advantage in production efficiency.
Wage Levels
- Wage differences can also play a role in determining comparative advantage.
How Trade Makes Us Wealthier
Key Points
- Trade moves goods to people who value them.
- Increases quantity and variety of goods available.
- Lowers the cost of goods.
Wealth in Economic Terms
Wealth is defined more broadly than just money; it includes the total value of all things a person owns. Wealth increases when we trade for things we value.
Impact of Trade on Goods and Services
Evolution of Cell Phones
- First cellular phone in 1983: weighed 2 pounds, cost $3,995, only made phone calls
- Modern cell phones: weigh <5 ounces, cost <$200, multi-functional
Variety of Goods Available
- In the U.S.: wide range of goods including multiple types of cheese
- In Nepal: limited variety, especially in rural areas
Trade Lowers Cost of Goods
- Comparative advantage: Goods may be cheaper if imported from countries that specialize in their production
- Economies of scale: Larger markets allow for mass production, reducing per-unit costs
Winners and Losers in Trade
Risks and Downsides
- Local industries may suffer due to cheaper imports.
- Job losses in sectors that can't compete internationally.
Economists' Perspective
Tim Harford's View
Tim Harford believes that it is not possible for trade to destroy all jobs and argues that there must be some level of export to sustain imports.
Creation and Destruction of Jobs
Old jobs may be lost, but new ones are created. More winners than losers in the long run.
Personal Implications
Focus on what you're good at for better life prospects.