EC 252 University of North Alabama Absolute Advantage in Producing Paper

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InstructionsUntil recently, the countries of Danoli and Herapi have been isolated from one another by an unnavigable stretch of ocean. Due to a large government grant, a six-lane bridge has been built between the two countries. Prior to the opening of the bridge, the two countries have been self-sustaining, producing the following: CoconutsMachetesDanoli30050Herapi10025You are the newly elected trade minister for the country of Danoli and have been task with developing trade with the people of Herapi. Your biggest challenge is convincing the leaders of your country to engage in trade.Prepare a minimum three-page write-up (double spaced) to present to the leaders of Danoli outlining the advantage of trading with the people of Herapi.Be sure to include, in your write-up, details of the following:Describe what conditions might determine why the countries produce at this level of output for the two goodsWhich country has the absolute advantage in producing each good and who has the comparative advantage, and the latter is most important in the decision to trade? (Give your numbers on this one)Explain why opportunity costs are relevant in the discussion of trade.What terms of trade would make exchange beneficial to most? (you may give a range)Given a terms of trade you set, what would be the outcome if we indeed trade with Herapi?How many coconuts and machetes would each country have after trade?

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Module 4 Notes
Gains From Trade
International trade allows countries to consume more goods than they can produce on
their own. They can do so by specializing in the production of goods for which they have
a comparative advantage. This is true even if the country has an absolute advantage on
producing all goods more efficiently than the other countries it can trade with.

Trade Advantage
What is comparative advantage? And why is it important to trade? This video guides us
through a specific example surrounding Tasmania — an island off the coast of Australia
that experienced the miracle of growth in reverse. Through this example we show what
can happen when a civilization is deprived of trade and show why trade is essential to
economic growth.
In an economy with a greater number of participants trading goods and services, there
are more ways to find a comparative advantage and earn more by creating the most
value for others.

Reguired Reading
•
Gwartney, Stroup, Sobel and Macpherson Chapter 18: “Gaining from
International Trade”
Trade Advantage
https://courses.lumenlearning.com/wm-microeconomics/chapter/comparative-advantage-and-thegains-from-trade/
Notes from AmosWeb Encyclonomic: Terms of Trade
The rate at which goods are traded, either between individuals or between
nations. It is the quantity of one good exchanged per unit of another good.
The terms of trade is essentially the price. But the price is stated in terms of
the quantity of another good. Like any market price, the terms of trade is
based on what the buyers are willing to pay and what the sellers are willing to
accept. The terms of trade between any two countries is based on the relative
opportunity cost in each country.
The terms of trade is the rate at which two trading partners agree
to exchange two goods. It is the price of one good stated in terms of another
good. This concept most often arises in the context of international trade, in
which the two trading partners are two different countries. However, in
principle, any exchange has terms of trade. The terms of trade in standard
markets is nothing more than the market price.
As a general rule, the terms of international trade between two countries falls
between the opportunity cost of production in each of the countries, with
adjustment for any transportation or shipping cost.
To illustrate the terms of trade, consider the exhibit to the right. This exhibit
illustrates the production alternatives facing two hypothetical countries. The
United Provinces of Csonda is a relatively industrialize and technologically
advanced country, not unlike the United States. The quaint and courteous
Republic of Northwest Queoldiola is a less advanced, less industrialized
country.
Both nations are able to produce two goods — turnips and sundials. In the
United Provinces of Csonda, one worker over a one-month period is able to
produce 60 pounds of turnips or 20 sundials. In contrast, in the Republic of
Northwest Queoldiola, one worker over a period of one month is able to
produce 20 pounds or turnips or 10 sundials.
Consider the cost of sundial production in the two countries.
•
•
If Csonda switches a unit of labor from turnip production to sundial
production, it is able to produce 20 sundials and in so doing gives up 60
pounds of turnips. As such, the production of each Csondan sundial
incurs an opportunity cost of 3 pounds of turnips.
In contrast, if Northwest Queoldiola switches a unit of labor from turnip
production to sundial production, it is able to produce 10 sundials, but in
so doing only gives up 20 pounds of turnips. As such, the production of
each Queoldiolan sundial incurs an opportunity cost of only 2 pounds of
turnips.
These numbers mean that Csonda is willing to pay up to 3 pounds of turnips
for each sundial. This can be thought of as Csonda’s demand price for
importing sundials from Northwest Queoldiola. If the “price” is any higher, then
Csonda is better off producing the sundials domestically.
On the other side of the exchange, Northwest Queoldiola is willing to accept
as low as 2 pounds of turnips for each sundial. This is basically Northwest
Queoldiola’s supply price for exporting sundials to Csonda. If the “price” is any
lower, then Northwest Queoldiola is better off consuming the sundials
domestically.
Now, let’s consider the opportunity cost of producing turnips.
•
•
If Csonda switches a unit of labor from sundial production to turnip
production, it is able to produce 60 pounds of turnips and in so doing
gives up only 20 sundials. As such, the production of each pound of
Csondan turnips incurs an opportunity cost of 1/3 (0.33) sundial.
In contrast, if Northwest Queoldiola switches a unit of labor from sundial
production to turnip production, it is able to produce 20 pounds of
turnips and in so doing gives up 10 sundials. As such, the production of
each pound of Queoldiolan turnips incurs an opportunity cost of 1/2
(0.5) sundial.
These numbers mean that Csonda is willing to accept as low as 0.33 sundial
for each pound of turnips. This can be thought of as Csonda’s supply price for
exporting turnips to Northwest Queoldiola. If the “price” is any lower, then
Csonda is better off consuming the turnips domestically.
On the other side of the exchange, Northwest Queoldiola is willing to pay up
to 0.5 sundial for each pound of turnips. This is basically Northwest
Queoldiola’s demand price for importing sundials from Csonda. If the “price” is
any higher, then Northwest Queoldiola is better off producing the turnips
domestically.
The United Provinces of Csonda is wise to use its labor to produce turnips,
which it can then trade to Northwest Queoldiola for sundials. On the other side
of the border, Northwest Queoldiola is wise to use its labor to produce
sundials, which it can then trade to Csonda for turnips.
•
•
The Price of Sundials: Csonda incurs a cost of 3 pounds of turnips per
sundial (its demand price) and Northwest Queoldiola incurs a cost of
only 2 pounds of turnips (its supply price). Like any market price, the
terms of trade for sundials is mutually agreeable to both sides. In this
case, Csonda and Northwest Queoldiola are both willing to make a
trade if the terms are between 2 and 3 pounds per sundial. If, for
example, Csonda gave Northwest Queoldiola 2.5 pounds of turnips in
each for each sundial (or 5 pounds of turnips for 2 sundials), then both
nations are better off.
The Price of Turnips: Now consider the other side of this trade.
Northwest Queoldiola incurs a cost of 0.5 sundial per pound of turnips
(its demand price) and Csonda incurs a cost of only 0.33 sundial (its
supply price). Northwest Queoldiola won’t go above 0.5 sundial and
Csonda won’t go below 0.33 sundial for each pound of turnips traded. If,
Northwest Queoldiola gave Csonda 0.4 sundial per pound of turnips
(which also works out to 2 sundials for 5 pounds of turnips), then both
nations are better off.
If Csonda and Northwest Queoldiola exchange sundials and turnips at a rate
of 2 sundials per 5 pounds of turnips, then the terms of trade is 2.5 pounds of
turnips per sundial or 0.5 sundials per pound of turnips.
Transit Costs
The terms of trade in this hypothetical example of exchange between Csonda
and Northwest Queoldiola assumes that turnips and sundials can be shipped
without cost between the two nations. Such is not a realistic assumption.
In the real world, the terms of trade between two countries is adjusted for
transit cost. That is, the “buying” or importing nation pays a slightly higher
price that the “selling” or exporting receives, with the difference used to pay
transit cost.
For example, Csonda might actually pay 2.6 pounds of turnips per sundial
when importing sundials from Northwest Queoldiola. However, Northwest
Queoldiola sundial producers might end up receiving only 2.4 pounds of
turnips per sundial. The 0.2 pound difference is then used pay the cost of
shipping sundials and turnips.
Notes from AmosWeb Encyclonomic: Division of Labor
A basic economic notion that labor resources are used more efficiently if work
tasks are divided among different workers. This allows workers to specialize in
production as each becomes highly skilled at specific tasks.
Efficiency achieved through specialization and the division of labor was
popularized by Adam Smith in his classic work, The Wealth of Nations.
Specialization and Production
Suppose, for example, that Patrick Pennington plans to provide pizza to the
people of Pittsburg by building a pizza parlor that employs 10 pizza workers.
Patrick could, if he so chose, train each worker to perform every pizza-related
task–waiting tables, kneading dough, spreading sauce, slicing meat,
accepting payment, washing dishes, etc. And Patrick would likely produce an
ample quantity of pizza to the people of Pittsburg.
But, Patrick’s employees would likely perform more productively if he trains
each in a specific task. One takes orders, another kneads the dough, a third
spreads the sauce, etc. As each worker concentrates on a given task, each
becomes more proficient. The workers waste less time running around the
pizza parlor bumping into each other. They learn the best, more efficient,
ways to do their specific jobs. All-in-all, Patrick gets more pizza per worker,
and the pizza consuming people of Pittsburg are positively pleased.
A Complex Economy
This division-of-labor notion is one of those concepts that is so fundamental to
the economy that its importance is occasionally overlooked in the real world.
Without the division of labor, the comfortable living standard currently
provided by members of the exceeding complex economic system would not
be possible.
For example, complex goods involving hundreds or even thousands
of production stages, components, and intermediate goods could not be
produced without specialization and the division of labor. Or if produced, they
would be incredibly expensive. Automobiles, airplanes, computers, motion
pictures, processed foods, and even education are but a few examples of
products that probably would not exist without the division of labor.
Foreign Trade
Foreign trade is a key area of economic activity in which the division of labor
is important and often overlooked. Trade among nations, like trade within a
nation, improves living standards as workers divide up production tasks. In
particular, suppose the workers in one nation specialize in agricultural
productions while the workers in another nation specialize in manufactured
products. When they trade these products, each nation is better off.

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