微觀經(jīng)濟(jì)學(xué)（第八版-英文）課件：General Equilibrium and Economic Efficiency

16.1

GeneralEquilibriumAnalysis16.2

EfficiencyinExchange16.3

EquityandEfficiency16.4

EfficiencyinProduction16.5

TheGainsfromFreeTrade16.6

AnOverview—TheEfficiencyofCompetitiveMarkets16.7 WhyMarketsFail

GeneralEquilibriumand

EconomicEfficiencyCHAPTEROUTLINEGeneralEquilibriumAnalysis16.1●

partialequilibriumanalysisDeterminationofequilibriumpricesandquantitiesinamarketindependentofeffectsfromothermarkets.●

generalequilibriumanalysisSimultaneousdeterminationofthepricesandquantitiesinallrelevantmarkets,takingfeedbackeffectsintoaccount.Afeedbackeffectisapriceorquantityadjustmentinonemarketcausedbypriceandquantityadjustmentsinrelatedmarkets.Inpractice,acompletegeneralequilibriumanalysis,whichevaluatestheeffectsofachangeinonemarketonallothermarkets,isnotfeasible.Instead,weconfineourselvestotwoorthreemarketsthatarecloselyrelated.Forexample,whenlookingatataxonoil,wemightalsolookatmarketsfornaturalgas,coal,andelectricity.TWOINTERDEPENDENTMARKETS:(A)MOVIETICKETSAND(B)DVDRENTALSFIGURE16.1(1of2)Whenmarketsareinterdependent,thepricesofallproductsmustbesimultaneouslydetermined.HereataxonmovieticketsshiftsthesupplyofmoviesupwardfromSMtoS*M,asshownin(a).Thehigherpriceofmovietickets($6.35ratherthan$6.00)initiallyshiftsthedemandforDVDsupward(fromDVtoD’V),causingthepriceofDVDstorise(from$3.00to$3.50),asshownin(b).TwoInterdependentMarkets—MovingtoGeneralEquilibriumTWOINTERDEPENDENTMARKETS:(A)MOVIETICKETSAND(B)DVDRENTALSFIGURE16.1(2of2)Thehighervideopricefeedsbackintothemovieticketmarket,causingdemandtoshiftfromDMtoD’Mandthepriceofmoviestoincreasefrom$6.35to$6.75.Thiscontinuesuntilageneralequilibriumisreached,asshownattheintersectionofD*MandS*Min(a),withamovieticketof$6.82,andtheintersectionofD*V

andSVin(b),withaDVDpriceof$3.58.ReachingGeneralEquilibriumIntheend,wemustdeterminetheequilibriumpricesandquantitiesof

bothmoviesandDVDssimultaneously.

Tofindthegeneralequilibriumprices(andquantities)inpractice,wemustsimultaneouslyfindtwopricesthatequatequantitydemandedandquantitysuppliedinallrelatedmarkets.Forourtwomarkets,weneedtofindthesolutiontofourequations(supplyofmovietickets,demandformovietickets,supplyofDVDs,anddemandforDVDs).

Inthisexample,partialequilibriumanalysiswouldleadustoconcludethatthetaxwillincreasethepriceofmovieticketswouldincreasebyless.Ageneralequilibriumanalysis,however,showsusthattheimpactofthetaxonthepriceofmovieticketsisgreater.MoviesandDVDsaresubstitutegoods.Ifthegoodsinquestionwerecomplements,apartialequilibriumanalysiswouldoverstatetheimpactofatax.EXAMPLE16.1THEGLOBALMARKETFORETHANOLTheworldethanolmarketisdominatedbyBrazilandthe

UnitedStates,whichaccountedforover90percentof

worldproductionin2005.TheU.S.andBrazilianethanolmarketsarecloselytiedto

eachother.Asaconsequence,theU.S.regulationofits

ownethanolmarketcansignificantlyaffectBrazil’s

market.Tospuralternativestogasoline,theU.S.offeredataxcreditof$0.51pergallonofethanol.Moreover,topreventforeignethanolproducersfromreapingthebenefitsofthistaxcredit,theU.S.governmentimposeda$0.54pergallontaxonimportedethanol.Thepolicyhasbeenhighlyeffective.Whilethispolicyhasbenefitedcornproducers,itisnotintheinterestsofU.S.ethanolconsumers.Consumerswouldbenefitifthetaxandsubsidywereremoved.EXAMPLE16.1THEGLOBALMARKETFORETHANOLREMOVINGTHEETHANOLTARIFFONBRAZILIANEXPORTSFIGURE16.2IfU.S.tariffsonethanolproducedabroadweretoberemoved,BrazilwouldexportmuchmoreethanoltotheUnitedStates,displacingmuchofthemoreexpensivecorn-basedethanolproduceddomestically.Asaresult,thepriceofethanolintheU.S.wouldfall,benefitingU.S.consumers.EXAMPLE16.2“CONTAGION”ACROSSSTOCKMARKETSAROUNDTHEWORLDStockmarketsaroundtheworldtendtomovetogether,aphenomenonreferredtoas“contagion.”Thereasonswhytheymovetogetheraremanifestationsofgeneralequilibrium.First,stock(andbond)marketsarehighlyintegrated.Anyexternalshocksthataffectstockpricesinonecountrywillhavethesamedirectionaleffectonpricesinothercountries.Thesecondreasonisthateconomicconditionsaroundtheworldtendtobecorrelated,andeconomicconditionsareanimportantdeterminantofstockprices.ArecessionintheUnitedStatescanleadtoarecessioninEurope,andviceversa.EXAMPLE16.2“CONTAGION”ACROSSSTOCKMARKETSAROUNDTHEWORLDSTOCKPRICESINTHEUNITEDSTATESANDEUROPEFIGURE16.3Threestockmarketindices—theS&P500intheUnitedStates,theFTSEintheUnitedKingdom,andtheDAXinGermany—areplottedtogether,scaledsothateachstartsat100in1984.Theindicestendtomovetogether,increasinganddecreasingataboutthesametime.EconomicEfficiencyWhenappliedtoacompetitivemarket,thetermeconomicefficiency

referstoamarketthatmaximizesaggregateconsumerandproducersurplus.Fortunately,thereisaconceptofeconomicefficiencythatapplieswhenthereisnomarketatall.Wearenowfocusingontheinterplayofmultiplemarketswithmultipleentitiescompetingagainsteachotherortradingwitheachother.Moreover,thereareimportantequityimplicationsthatflowfromtheworkingsofcompetitivemarketsingeneralequilibrium.Wewillfocusontwo,ratherthanmanycountries(eachrepresentedbyadifferentindividualconsumerorproducer),andtwo,ratherthanmany,goodsandservices.We’llstartwithamodelofexchangeinwhichthereisnoproduction,andalsoinitiallyassumethatthetwoindividuals(representingtwocountries)havesomeendowmentofgoods.Tradingoccursbecauseitmakesbothindividualsbetteroff.Later,we’llintroduceproduction,andrevisittechnicalefficiency.Finally,wewillmoveontotheanalysisofcompetitivemarkets.EfficiencyinExchange16.2●

exchangeeconomyMarketinwhichtwoormoreconsumerstradetwogoodsamongthemselves.●

ParetoefficientallocationSimultaneousdeterminationofthepricesandquantitiesinallrelevantmarkets,takingfeedbackeffectsintoaccount.ParetoefficiencyisnotthesameaseconomicefficiencyaswedefineditinChapter9.WithParetoefficiency,weknowthatthereisnowaytoimprovethewell-beingofbothindividuals(ifweimproveone,itwillbeattheexpenseoftheother),butwecannotbeassuredthatthisarrangementwillmaximizethejointwelfareofbothindividuals.NotethatthereisanequityimplicationofParetoefficiency.Itmaybepossibletoreallocatethegoodsinawaythatincreasesthetotalwell-beingofthetwoindividuals,butleavesoneindividualworseoff.Ifwecanreallocategoodssothatoneindividualisjustslightlyworseoffbuttheotherindividualismuch,muchbetteroff,wouldn’tthatbeagoodthingtodo,eventhoughitisnotParetoefficient?TheAdvantagesofTradeTABLE16.1THEADVANTAGEOFTRADEINDIVIDUALINITIALALLOCATIONTRADEFINALALLOCATIONJames7F,1C–1F,+1C6F,2CKaren3F,5C+1F,–1C4F,4CKarenhasalotofclothingandlittlefood,hermarginalrateofsubstitution(MRS)offoodforclothingis3:Toget1unitoffood,shewillgiveup3unitsofclothing.Thereisroomformutuallyadvantageoustrade.Togetanotherunitoffood,Karenwouldbewillingtotradeupto3unitsofclothing.ButJameswillgiveup1unitoffoodfor1/2unitofclothing.Theactualtermsofthetradedependonthebargainingprocess.Amongthepossibleoutcomesareatradeof1unitoffoodbyJamesforanywherebetween1/2and3unitsofclothingfromKaren.Whenevertwoconsumers’MRSsaredifferent,thereisroomformutuallybeneficialtrade.Conversely,anallocationofgoodsisefficientonlyifthegoodsaredistributedsothatthemarginalrateofsubstitutionbetweenanypairofgoodsisthesameforallconsumers.TheEdgeworthBoxDiagram●

EdgeworthboxDiagramshowingallpossibleallocationsofeither

twogoodsbetweentwopeopleoroftwoinputsbetweentwoproductionprocesses.EXCHANGEINANEDGEWORTHBOXFIGURE16.4EachpointintheEdgeworthboxsimultaneouslyrepresentsJames’sandKaren’smarketbasketsoffoodandclothing.AtA,forexample,Jameshas7unitsoffoodand1unitofclothing,andKaren3unitsoffoodand5unitsofclothing.Jamesgivesup1Finexchangefor1C,movingfromAtoB.Karengivesup1Candobtains1F,alsomovingfromAtoB.PointBthusrepresentsthemarketbasketsofbothJamesandKarenafterthemutuallybeneficialtrade.EfficientAllocationsEFFICIENCYINEXCHANGEFIGURE16.5TheEdgeworthboxillustratesthepossibilitiesforbothconsumerstoincreasetheirsatisfactionbytradinggoods.IfAgivestheinitialallocationofresources,theshadedareadescribesallmutuallybeneficialtrades.Evenifatradefromaninefficientallocationmakesbothpeoplebetteroff,thenewallocationisnotnecessarilyefficient.Whentheindifferencecurvesaretangent,onepersoncannotbemadebetteroffwithoutmakingtheotherpersonworseoff.CandDarebothefficientallocations,althoughJamesprefersDtoCandKarenCtoD.Ingeneral,theallocationthatwillbereachedinabargaindependsonthebargainingabilitiesofthepeopleinvolved.TheContractCurveTHECONTRACTCURVEFIGURE16.6Thecontractcurvecontainsallallocationsforwhichconsumers’indifferencecurvesaretangent.Everypointonthecurveisefficientbecauseonepersoncannotbemadebetteroffwithoutmakingtheotherpersonworseoff.●

contractcurveCurveshowingallefficientallocationsofgoods

betweentwoconsumers,oroftwoinputsbetweentwoproductionfunctions.ConsumerEquilibriuminaCompetitiveMarketCOMPETITIVEEQUILIBRIUMFIGURE16.7Inacompetitivemarketthepricesofthetwogoodsdeterminethetermsofexchangeamongconsumers.IfAistheinitialallocationofgoodsandthepricelinePP′representstheratioofprices,thecompetitivemarketwillleadtoanequilibriumatC,thepointoftangencyofbothindifferencecurves.Asaresult,thecompetitiveequilibriumisefficient.Anequilibriumisasetofpricesatwhichthequantitydemandedequalsthequantitysuppliedineverymarket.Thisisalsoacompetitiveequilibriumbecauseallsuppliersanddemandersarepricetakers.Themarketisindisequilibriumwhenthequantitiesoffoodand

clothingdemandedarenotequaltothequantitiessupplied.Thisdisequilibriumshouldbeonlytemporary.●

excessdemandWhenthequantitydemandedofagoodexceedsthequantitysupplied.●

excesssupplyWhenthequantitysuppliedofagoodexceedsthequantitydemanded.Inourexample,eachKaren’squantitydemandedforfoodisgreaterthaneachJames’swillingnesstosellit,whereaseachKaren’swillingnesstotradeclothingisgreaterthaneachJames’squantitydemanded.Asaresultofthisexcessquantitydemandedforfoodandexcessquantitysuppliedofclothing,wecanexpectthepriceoffoodtoincreaserelativetothepriceofclothing.Asthepricechanges,sowillthequantitiesdemandedbyallthoseinthemarket.Eventually,thepriceswilladjustuntilanequilibriumisreached.TheEconomicEfficiencyofCompetitiveMarketsWecannowunderstandoneofthefundamentalresultsof

microeconomicanalysis.WecanseefrompointCinFigure16.6thattheallocationinacompetitiveequilibriumisParetoefficient.ThekeyreasonwhythisissoisthatCmustoccuratthetangencyoftwoindifferencecurves.Ifitdoesnot,oneoftheJamesesoroneoftheKarenswillnotbeachievingmaximumsatisfaction;heorshewillbewillingtotradetoachieveahigherlevelofutility.Thisresultholdsinanexchangeframeworkandinageneralequilibriumsettinginwhichallmarketsareperfectlycompetitive.ItisthemostdirectwayofillustratingtheworkingsofAdamSmith’sfamousinvisiblehand,becauseittellsusthattheeconomywillautomaticallyallocateresourcesinaParetoefficientmannerwithouttheneedforregulatorycontrol.TheresultthatacompetitiveequilibriumisParetoefficientisoftendescribedasthefirsttheoremofwelfareeconomics.Ifeveryonetradesinthecompetitivemarketplace,allmutuallybeneficialtradeswillbecompletedandtheresultingequilibriumallocationofresourceswillbeeconomicallyefficient.●

welfareeconomicsNormativeevaluationofmarketsandeconomicpolicyLet’ssummarizewhatweknowaboutacompetitiveequilibriumfromtheconsumer’sperspective:1. Becausetheindifferencecurvesaretangent,allmarginalratesofsubstitutionbetweenconsumersareequal.2. Becauseeachindifferencecurveistangenttothepriceline,eachperson’sMRSofclothingforfoodisequaltotheratioofthepricesofthetwogoods.(16.1)

EquityandEfficiency16.3UTILITYPOSSIBILITIESFRONTIERFIGURE16.8TheUtilityPossibilitiesFrontier●

utilitypossibilitiesfrontier Curveshowingallefficientallocationsofresourcesmeasuredintermsoftheutilitylevelsoftwoindividuals.Theutilitypossibilitiesfrontiershowsthelevelsofsatisfactionthateachoftwopeopleachievewhentheyhavetradedtoanefficientoutcomeonthecontractcurve.PointsE,F,andGcorrespondtopointsonthecontractcurveandareefficient.PointHisinefficientbecauseanytradewithintheshadedareawillmakeoneorbothpeoplebetteroff.InFigure16.8,pointH

representsaninefficientallocationbecauseanytradewithintheshadedareamakesoneorbothpartiesbetteroff.AtL,bothpeoplewouldbebetteroff,butLisnotattainablebecausethereisnotenoughofbothgoodstogeneratethelevelsofutilitythatthepointrepresents.ItmightseemreasonabletoconcludethatanallocationmustbeParetoefficienttobeequitable.ComparepointHwithFandE.BothFandEareefficient,and(relativetoH)eachmakesonepersonbetteroffwithoutmakingtheotherworseoff.Wemightagree,therefore,thatitisinequitabletoJamesorKarenorbothforaneconomytoyieldallocationHasopposedtoForE.ButsupposeHandGaretheonlypossibleallocations.IsGmoreequitablethanH?Notnecessarily.ComparedwithH,GyieldsmoreutilityforJamesandlessforKaren.SomepeoplemayfeelthatGismoreequitablethanH;othersmayfeeltheopposite.Wecanconclude,therefore,thatoneParetoinefficientallocationofresourcesmaybemoreequitablethananotherParetoefficientallocation.Theproblemishowtodefineanequitableallocation.Evenifwerestrictourselvestoallpointsontheutilitypossibilitiesfrontier,wecanstillaskwhichofthesepointsisthemostequitable.Theanswerdependsonwhatonethinksequityentailsand,therefore,ontheinterpersonalcomparisonsofutilitythatoneiswillingtomake.SOCIALWELFAREFUNCTIONS●

socialwelfarefunctionMeasuredescribingthewell-beingof

societyasawholeintermsoftheutilitiesofindividualmembers.Asocialwelfarefunctionisusefulwhenwewanttoevaluatepoliciesthataffectsomemembersofsocietydifferentlythanothers.Onesuchfunction,theutilitarian,weightseveryone’sutilityequallyandconsequentlymaximizesthetotalutilityofallmembersofsociety.Eachsocialwelfarefunctioncanbeassociatedwithaparticularviewaboutequity.Butsomeviewsdonotexplicitlyweightindividualutilitiesandcannotthereforeberepresentedbyasocialwelfarefunction.Forexample,amarket-orientedviewarguesthattheoutcomeofthecompetitivemarketprocessisequitablebecauseitrewardsthosewhoaremostableandwhoworkthehardest.IfEisthecompetitiveequilibriumallocation,forexample,EwouldbedeemedtobemoreequitablethanF,eventhoughgoodsarelessequallyallocated.Whenmorethantwopeopleareinvolved,themeaningoftheword

equitybecomesevenmorecomplex.TheRawlsianviewconsidersaworldinwhichindividualsdonotknowwhattheirindividualendowmentswillbe.Rawlsarguesthat,facedwithaworldinwhichyoudonotknowyourown“fate,”youwouldoptforasystemassuringthattheleastwell-offpersoninsocietywillbetreatedreasonablywell.Specifically,accordingtoRawls,themostequitableallocationmaximizestheutilityoftheleast-well-offpersoninsociety.TheRawlsianperspectivecouldbeegalitarian—involvinganequalallocationofgoodsamongallmembersofsociety.Butitneednotbe.Supposethatbyrewardingmoreproductivepeoplemorehighlythanlessproductivepeople,wecangetthemostproductivepeopletoworkharder.Thispolicycouldproducemoregoodsandservices,someofwhichcouldthenbereallocatedtomakethepoorestmembersofsocietybetteroff.TABLE16.2FOURVIEWSOFEQUITY1.Egalitarian—allmembersofsocietyreceiveequalamountsofgoods2.Rawlsian—maximizetheutilityoftheleast-well-offperson3.Utilitarian—maximizethetotalutilityofallmembersofsociety4.Market-oriented—themarketoutcomeisthemostequitableThefourviewsofequityinTable16.2moveroughlyfrommosttoleastegalitarian.Whiletheegalitarianviewexplicitlyrequiresequalallocations,theRawlsianputsaheavyweightonequality(otherwise,somepeoplewouldbemuchworseoffthanothers).Theutilitarianislikelytorequiresomedifferencebetweenthebest-andworst-offmembersofsociety.Finally,themarket-orientedviewmayleadtosubstantialinequalityintheallocationsofgoodsandservices.EquityandPerfectCompetitionTheresultthatacompetitiveequilibriumcansustaineverypointonthe

contractcurveisafundamentalresultinmicroeconomics.Itisimportantbecauseitsuggestsananswertoabasicnormativequestion:Isthereatrade-offbetweenequityandefficiency?Inotherwords,mustasocietythatwishestoachieveamoreequitableallocationofresourcesnecessarilyoperateinamannerthatisParetoefficient?Theanswer,whichisgivenbythesecondtheoremofwelfareeconomics,tellsusthatredistributionneednotconflictwitheconomicefficiency.Formally,thesecondtheoremstatesthefollowing:Ifindividualpreferencesareconvex,theneveryParetoefficientallocation(everypointonthecontractcurve)isacompetitiveequilibriumforsomeinitialallocationofgoods.Literally,thistheoremtellsusthatanyequilibriumdeemedtobeequitablecanbeachievedbyasuitabledistributionofresourcesamongindividualsandthatsuchadistributionneednotinitselfgenerateinefficiencies.Unfortunately,allprogramsthatredistributeincomeinoursocietyareeconomicallycostly.Taxesmayencourageindividualstoworklessorcausefirmstodevoteresourcestoavoidingtaxesratherthantoproducingoutput.So,ineffect,thereisatrade-offbetweenthegoalsofequityandefficiency,andhardchoicesmustbemade.EfficiencyinProduction16.4InputEfficiency●

technicalefficiency Conditionunderwhichfirmscombineinputstoproduceagivenoutputasinexpensivelyaspossible.Aparticularallocationofinputsintotheproductionprocessistechnicallyefficientiftheoutputofonegoodcannotbeincreasedwithoutdecreasingtheoutputofanothergood.Becausetechnicalefficiencyrequirestheappropriatecombinationofinputs,wewillalsocallitinputefficiency.Ifinputmarketsarecompetitive,apointofefficientproductionwillbeachieved.Let’sseewhy.Ifthelaborandcapitalmarketsareperfectlycompetitive,thenthewageratewwillbethesameinallindustries.Likewise,therentalrateofcapitalrwillbethesamewhethercapitalisusedinthefoodorclothingindustry.Fromchapter7weknowthattominimizeproductioncosts,producerswillusecombinationsoflaborandcapitalsothat:and,

(16.2)BecausetheMRTSistheslopeofthefirm’sisoquant,thecompetitiveequilibriumisefficientinproduction.

TheProductionPossibilitiesFrontier●

productionpossibilitiesfrontier Curveshowingthecombinations

oftwogoodsthatcanbeproducedwithfixedquantitiesofinputs.PRODUCTIONPOSSIBILITIESFRONTIERFIGURE16.9Theproductionpossibilitiesfrontiershowsallefficientcombinationsofoutputs.Theproductionpossibilitiesfrontierisconcavebecauseitsslope(themarginalrateoftransformation)increasesasthelevelofproductionoffoodincreases.●

marginalrateoftransformation Amountofonegoodthatmustbegivenuptoproduceoneadditionalunitofasecondgood.Notethatasweincreasetheproductionoffoodbymovingalongtheproductionpossibilitiesfrontier,theMRTincreases.WhentheMRTislow,soistheratioofthemarginalcostofproducingfoodMCF

tothemarginalcostofproducingclothingMCC.Infact,theslopeoftheproductionpossibilitiesfrontiermeasuresthemarginalcostofproducingonegoodrelativetothemarginalcostofproducingtheother.Ateverypointalongthefrontier,thefollowingconditionholds:MARGINALRATEOFTRANSFORMATION

(16.3)OutputEfficiencyForaneconomytobeefficient,goodsmustnotonlybeproducedatminimumcost;goodsmustalsobeproducedincombinationsthatmatchpeople’swillingnesstopayforthem.Themarginalrateoftransformationmeasuresthecostofanadditionalunitoffoodintermsofproducinglessclothing.Aneconomyproducesoutputefficientlyonlyif,foreachconsumer,

(16.4)Toseewhythisconditionisnecessaryforefficiency,supposetheMRTequals1,whiletheMRSequals2.Inthatcase,consumersarewillingtogiveup2unitsofclothingtoget1unitoffood,butthecostofgettingtheadditionalfoodisonly1unitoflostclothing.Clearly,toolittlefoodisbeingproduced.Toachieveefficiency,foodproductionmustbeincreaseduntiltheMRSfallsandtheMRTincreasesandthetwoareequal.TheoutcomeisoutputefficientonlywhenMRS=MRTforallpairsofgoods.OUTPUTEFFICIENCYFIGURE16.10Theefficientcombinationofoutputsisproducedwhenthemarginalrateoftransformationbetweenthetwogoods(whichmeasuresthecostofproducingonegoodrelativetotheother)isequaltotheconsumer’smarginalrateofsubstitution(whichmeasuresthemarginalbenefitofconsumingonegoodrelativetotheother).EfficiencyinOutputMarketsWhenoutputmarketsareperfectlycompetitive,allconsumersallocatetheirbudgetssothattheirmarginalratesofsubstitutionbetweentwogoodsareequaltothepriceratio.Forourtwogoods,foodandclothing,

(16.5)Atthesametime,eachprofit-maximizingfirmwillproduceitsoutputuptothepointatwhichpriceisequaltomarginalcost.Again,forourtwogoods,

Becausethemarginalrateoftransformationisequaltotheratioofthemarginalcostsofproduction,itfollowsthat

COMPETITIONANDOUTPUTEFFICIENCYFIGURE16.11Inacompetitiveoutputmarket,peopleconsumetothepointwheretheirmarginalrateofsubstitutionisequaltothepriceratio.Producerschooseoutputssothatthemarginalrateoftransformationisequaltothepriceratio.BecausetheMRSequalstheMRT,thecompetitiveoutputmarketisefficient.Anyotherpriceratiowillleadtoanexcessdemandforonegoodandanexcesssupplyoftheother.TheGainsfromFreeTrade16.5ComparativeAdvantage●

comparativeadvantage SituationinwhichCountry1hasanadvantageoverCountry2inproducingagoodbecausethecostofproducingthegoodin1,relativetothecostofproducingothergoodsin1,islowerthanthecostofproducingthegoodin2,relativetothecostofproducingothergoodsin2.●

absoluteadvantage SituationinwhichCountry1hasanadvantageoverCountry2inproducingagoodbecausethecostofproducingthegoodin1islowerthanthecostofproducingitin2.TABLE16.3HOURSOFLABORREQUIREDTOPRODUCECHEESEANDWINECHEESE(1LB)WINE(1GAL)Holland12Italy63WHATHAPPENSWHENNATIONSTRADEThecomparativeadvantageofeachcountrydetermineswhathappenswhentheytrade.Theoutcomewilldependonthepriceofeachgoodrelativetotheotherwhentradeoccurs.Supposethatwithtrade,onegallonofwinesellsforthesamepriceasonepoundofcheeseinbothHollandandItaly.Supposealsothatbecausethereisfullemploymentinbothcountries,theonlywaytoincreaseproductionofwineistotakelaboroutoftheproductionofcheese,andviceversa.Bothcountrieshave24hoursoflaborinputavailable.ItisinHolland’sinteresttospecializeintheproductionofcheese,whichitwillexporttoItalyinexchangeforwine.If,forexample,Hollandproduced24poundsofcheeseandtraded6,itwouldbeabletoconsume18poundsofcheeseand6gallonsofwine—adefiniteimprovementoverthe18poundsofcheeseand3gallonsofwineavailableintheabsenceoftrade.SpecializationinwineproductionisadvantageousforItaly.SupposethatItalyproduced8gallonsofwineandtraded6;inthatcase,itwouldbeabletoconsume6poundsofcheeseand2gallonsofwine—likewiseanimprovementoverthe3poundsofcheeseand2gallonsofwineavailablewithouttrade.AnExpandedProductionPossibilitiesFrontierTHEGAINSFROMTRADEFIGURE16.12Withouttrade,productionandconsumptionareatpointA,wherethepriceofwineistwicethepriceofcheese.Withtradeatarelativepriceof1cheeseto1wine,domesticproductionisnowatB,whiledomesticconsumptionisatD.FreetradehasallowedutilitytoincreasefromU1toU2.EXAMPLE16.3TRADINGTASKSANDIPODPRODUCTIONAtypicalproductembodiesasequenceoftasks,eachofwhichcanalsobetrad