Macroeconomics Big Idea

Macroeconomics BIG IDEA: TRADE IS GOOD! 1. Trade is a non-zero sum game through which participants specialize based on their comparative advantage [lowest opportunity cost] and exchange goods and services. The results include: a. a consumption possibility through trade greater than what could be achieved through autarky [production alone without trade/self-sufficiency] b. a higher standard of living in both countries – [same as a.] c. more efficient allocation of productive resources in both countries ▪ greater efficiency in both countries 2. Consequences of trade barriers: a. a consumption possibility less than what could be achieved through trade b. a lower standard of living in both countries – [same as a.] c. less efficient allocation of productive resources in both countries ▪ less efficiency in both countries 3. A few words on PROTECTIONISM a. ALL protectionist policies have serious consequences as listed above in #2 “Consequences of trade barriers” b. Trade barriers are only justifiable on political/value-based grounds. Two circumstances tend to exist for trade barriers despite the myriad of different seeming circumstances. i. A mode of production vital to national interests and/or the common good of a people require protection and/or significant government regulation inhibiting free trade. ii. A powerful lobby utilizes the mechanisms of government to protect them against competition. This is functionally a conspiracy against the national interests/common goods through the complicity of government.  [Typical Absolute/Comparative Advantage Questions]: 1. Absolute advantage is simply who can make more with the same # of resources, time, or other common denominator. Atlantis has absolute advantage because X > Y, with the same resources. 2. Absolute advantage can be held by one player in both goods, both players in one good, and one player in zero goods. 3. Comparative advantage means lowest opportunity cost – whoever gives up the least Y per unit X produced has absolute advantage in X. 4. Comparative advantage cannot be held in both goods or zero goods. It must be split between the players (law of MATH). A possible exception is if both countries have exactly the same production possibility curves for both goods a very unlikely question prompt. 5. [Input/Output Method] This is a FALSE dichotomy. There is only an output method – absolute and comparative advantages are always referring to products. Some questions present the data in the form of some factor/input, such as units of farmland, time, etc. Do not fall for the trick. If you do not recognize whether or not the original data of the question is input or output, you run the risk of having the opposite answer. The supposed input method is simply taking the data provided and turning it into how much stuff each player can make. Output (Product Market) Input (Factor Market) (assume with same amount of resources) (assume hours per 1 unit of goods) Atlantis: 10 guns or 20 butter Xanadu: 2 guns or 10 butter Atlantis has absolute advantage in guns because 10 > 2 with the same amount of resources. Atlantis has absolute advantage in butter because 20 > 10 with the same amount of resources. Atlantis can make 1 gun or 2 butter. Atlantis per/unit opportunity cost of 1G is 2B. Atlantis can make 1 butter or ½ gun. Atlantis per/unit opportunity cost of 1B is ½G. Xanadu can make 1 gun or 5 butter. Xanadu per/unit opportunity cost of 1G is 5B. Xanadu can make 1 butter or 1/5 gun. Xanadu per/unit opportunity cost of 1B is 1/5G. Atlantis has comparative advantage in guns because their opportunity cost per 1G is 2B and Xanadu’s opportunity cost per 1G is 5B. [2B < 5B] Xanadu has comparative advantage in butter because their opportunity cost per 1B is 1/5G and Atlantis’s opportunity cost per 1B is ½G. [1/5G < ½G] Atlantis should specialize in guns. Xanadu should specialize in butter. Atlantis: exports guns, imports butter. Xanadu: exports butter, imports guns Acceptable terms of trade must be better than autarky. Atlantis must get >2B per 1G. Xanadu must get >1/5G per 1B. … therefore, acceptable per unit terms of trade: Atlantis: exports 1G for imports >2B to <5B Xanadu: imports 1G for exports >2B to <5B Atlantis: imports 1B for exports <½G to >1/5G Xanadu: export 1B for import <½G to >1/5G If terms were 1G : 3B, what are benefits? Atlantis: gain 1 more B per unit G, alone Xanadu: cost 2 fewer B per unit G, alone Alpha: 10 hours per gun or 20 hours per butter Beta: 2 hours per gun or 10 hours per butter Beta has absolute advantage in guns because 1 > 1/5 in the same amount of time. Beta has absolute advantage in butter because 2 > 1 in the same amount of time. Alpha can make 1 gun or ½ butter. Alpha per/unit opportunity cost of 1G is ½B. Alpha can make 1 butter or 2 gun. Alpha per/unit opportunity cost of 1B is 2G. Beta can make 1 gun or 1/5 butter. Beta per/unit opportunity cost of 1G is 1/5B. Beta can make 1 butter or 5 gun. Beta per/unit opportunity cost of 1B is 5G. Alpha has comparative advantage in butter because their opportunity cost per 1B is 2G and Beta’s opportunity cost per 1B is 5G. [2G < 5G] Beta has comparative advantage in guns because their opportunity cost per 1G is 1/5B and Alpha’s opportunity cost per 1G is 1/2B. [1/5B < ½ B] Alpha should specialize in butter. Beta should specialize in guns. Alpha: exports butter, imports guns. Beta: exports guns, imports butter. Acceptable terms of trade must be better than autarky. Alpha must get >2G per 1B. Beta must get >1/5B per 1G. … therefore, acceptable per unit terms of trade: Alpha: exports 1B for imports >2G to <5G Beta: imports 1B for exports >2G to <5G Alpha: imports 1G for exports <½B to >1/5B Beta: exports 1G for imports <½B to >1/5B If terms were 1B : 3G, what are benefits? Alpha: gain 1 more G per unit B, alone. Beta: cost 2 fewer G per unit B, alone