Why Do People Trade?

Capstone Lesson 44

Class Ranking of Tradable Items

Total Points

Round 1

Round 2

Round 3

Voluntary Trade

• Benefits both parties• Win-Win• Consider simple daily

examples• Consider city, state or

nation without trade

What are these people about to say to each other?

Absolute and Comparative Advantage

• Comparative Advantage: The comparison of the production of goods according to their opportunity cost.• Absolute Advantage: The comparison of the production of goods according to their productivity.

• Examples: U.S. and Mexico; Babe Ruth hitting and pitching

To Trade or Not to Trade?

• If you have an absolute advantage in everything would you still benefit from trade?

– Yes– Babe Ruth had a

comparative advantage as a hitter—opportunity cost of pitching is too high.

– Specialize where you have a comparative advantage—both parties better off (more wealth)

LeBron James and Scotty

• LeBron James is a great basketball player and a great lawn mower.• James could mow his lawn in 2 hours. •He could also film a Nike commercial in that time making $10,000 – opportunity cost of mowing yard.• His nieghbor Scotty can mow James’ lawn in 4 hours.•He could also work at McDonald’s and earn $32 – opportunity cost of mowing yard.

LeBron James and Scott

• James is better than Scotty at mowing grass—he has an absolute advantage.• Scotty has a comparative advantage mowing grass.• Would James still benefit from trade? Would Scotty?• Yes, as long as James pays Scotty more than $32 and less than $10,000 they are both better off (wealthier) than if this trade did not occur.

Other Applications

• People (countries) should specialize in what they are good at and trade for other stuff:

– Why don’t we grow our own food? Or build our own homes?

– Why do we use assembly lines?

– I don’t teach economics, biology, and history.

– Josh Freeman and Aaron Rogers don’t play every position on the field.

North American Free Trade Association

• Trading Members: Canada, Mexico, USA

• Purposes:– Reduce trade barriers– Increase economic activity

in North America– Improve the standard of

living of member nations

World Trade Ogranization• 153 countries are members. All

the major economies in the world are included.

• Purposes:– Promote trade among

countries by reducing trade barriers

– Establish common rules for trade

– Increase international trade– Improve the world’s standard

of living