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[SQUEAKING]

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[RUSTLING]

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[CLICKING]

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JONATHAN GRUBER:
Today, we're going

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to finish our
discussion of savings,

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continue my nagging
on you guys about how

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you should be saving money.

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And then we're going
to move on and talk

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about international trade.

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So let's finish our
discussion of savings.

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Now, savings turns out to be
a critically important element

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of growth in the economy.

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And we've now traced
through why that happens.

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Our basic story is
as savings goes up,

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that means that the
capital supply shifts out.

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So the capital
supply curve shifts

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outward as people save more.

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That's an increase
in the capital supply

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curve in the capital markets.

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That means that
interest rates fall.

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Because there's more
supply for given demand,

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the price is going to fall.

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The price of capital
is the interest rate.

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So as people save more,
that's more supply

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into capital markets.

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It's increasing the pool from
which firms have to borrow.

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For a given pool, firms
have to pay less money

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to borrow from that.

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If the interest rate
goes down, that means

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the NPV of investment
goes up, because remember,

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the net present
value of investments

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is a negative function
of the interest rate.

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The lower the interest
rate, the more firms

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will say I might as well buy a
new machine, because the bank's

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not paying anything.

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That means that NPV
investment goes up,

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which means investment goes up.

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So the bottom line
is, the way we

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get firms to invest
more and grow

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the economy is by saving more.

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We save more.

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We increase capital supply.

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That lowers the interest rate.

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That raises the
NPV of investment,

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which leads to more investment.

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So that's the link by which
savings lead economic growth,

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is that savings leads
firms to invest more.

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Is that clear from
the sort of structure

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we built in the last
couple lectures?

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If it's not, just
go back through

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and work through the math.

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But you'll see we talked
about the capital market.

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The interest rates, the price,
and the capital market--

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last time we talked about
the lower the interest rate,

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the higher the net present
value of any given investment.

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That means firms
will invest more.

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So that means a critical
public policy concern is

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getting people to save enough.

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Now, obviously, that varies
with economic conditions.

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In a deep recession, we don't
naturally want as much savings

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as when we're not in recession.

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But in general, in the long run,
we will grow more as an economy

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if we save more as a society.

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And the US has an
incredible low savings rate.

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Our savings rate in the US,
depending how you define it,

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is maybe 3% to 5%.

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In Europe, in Japan, it's
like 15-plus percent.

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So we have a very
low savings rate.

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And as a result, that has
led public policymakers

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to try to think about tools they
can use to encourage savings.

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And the major tool we
use in public policy

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to encourage savings is the tax
subsidy to retirement savings.

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The tax subsidy to
retirement savings

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is the major tool that we use
to increase savings in the US.

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Now, how does this work?

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The basic logic
is the following--

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When I put my money in the
bank and I earn interest,

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that interest gets taxed.

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Just like my labor
supply gets taxed,

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my capital income gets taxed.

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So when I put money in
the bank, I don't just

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earn the interest rate.

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We'll use our-- we don't care
about real interest rate.

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[INAUDIBLE] earn interest rate.

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I earn r times 1 minus tau,
where tau is the tax rate.

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That's all I take home.

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So the bank pays me 10%.

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Say inflation is zero,
so nominal interest rates

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are the same.

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If the bank pays me 10%
and my tax rate's 50%,

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I only take home 5% on that.

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If we assume substitution
effects dominate--

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which is a big assumption,
but typically one we make--

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this means the taxation, by
lowering the return to savings,

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will lead to less savings.

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So by taxing people's savings,
we lead to less of it,

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because we sort of assume
substitution effects dominate.

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To offset this, we say,
well, I'll tell you what--

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if you save for retirement,
we won't tax it.

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So if you save it, and
you pull it out next year,

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we're going to tax
it, but if you put it

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in special accounts which we've
labeled as retirement savings,

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we won't tax it.

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So these have a number of forms.

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One form is employer
sponsored pensions.

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These are things
where your employer

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takes some of your pay,
puts it aside in an account.

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And when he does that,
you're not taxed on that pay.

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So if MIT is going
to pay me $100,000,

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and they pull $10,000 aside
and put it in a pension,

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I'm only taxed on $90,000.

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That $10,000 isn't taxed.

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And likewise, the interest
that's earned on that

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isn't taxed.

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There's also 401(k)s.

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A 401(k) is like a pension, but
where you control the money.

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So when you get a job, you
might get offered a 401(k).

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That's something where
some of your money

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gets pulled out of your salary.

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It doesn't get taxed, and
it gets saved instead,

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and you control where it goes.

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And then we also have
individual retirement accounts,

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with the unfortunate name IRA.

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It's not the Irish
Republican Army,

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but individual retirement
accounts, which are similar

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features, where you
could take your money

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and save it on a tax-free basis.

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Now here's the trick about
how all these things work, is

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they're not actually tax free.

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They are tax deferred.

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And what do I mean by that?

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What I mean by that is that
when you take the money out

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eventually, it does get taxed.

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So the way, say, your
401(k) would work--

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you get a job at
whatever, Google.

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Google offers you a 401(k).

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You put money in it.

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That money then accumulates.

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And when you take it
out-- you put money in.

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That money is not taxed
when you put it in,

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but when you take
it out, it is taxed.

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So it is eventually taxed.

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So what good does that do you?

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What good does that
do you if it's going

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to get taxed eventually anyway?

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Yeah.

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AUDIENCE: If you don't
get taxed right now,

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you get more money now, which
will then accumulate more money

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through compound interest.

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JONATHAN GRUBER: Right.

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It takes advantage
of present value.

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Remember, we talked
about this last time.

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With present value, money in the
future is worth less than money

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today.

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By that same logic,
paying taxes in the future

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costs you less than
paying taxes today,

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because you have the money.

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You can earn all
this interest on it,

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and you have to pay taxes
on it off in the future.

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So let's see an example of that.

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Let's look at figure 18.1.

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Let's say you have two types
of accounts, a regular account,

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or an IRA account, which
is a tax-deferred account.

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And let's say the
tax rate is 25%

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and the interest rate is 10%.

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And let's say you're just
going to put the money in--

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to make life easy, imagine
put the money in for one year.

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Imagine you're
retiring next year.

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This is a super easy example.

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You're retiring next year.

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The question is, for
this last year of work,

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should you put your money
in a tax-deferred account

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or in a regular account?

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If you put it in
a regular account,

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you will take your $100 of
earnings to pay $25 of taxes

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right away.

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You only get to put $75 in.

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On that $75, you'll earn $7.50.

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And when you take the $7.50
out, you'll pay $1.88 in taxes.

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So you pay $25 on your earnings.

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You pay another $1.88 on
the interest you earned.

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And you end up with $80.62.

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Now let's say instead,
you set up an IRA.

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There, you get to put
the whole $100 in.

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That $100 earns $10.

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And when you take out $110,
then you pay tax on it,

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so you pay $27.50,
then, in the end.

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But if you put it all together,
you end up with more money--

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$82.50 rather than $80.62.

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Why is that?

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It's because you delayed
paying taxes by a year.

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By paying taxes
one year later, you

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got to earn the interest on
that money during the year.

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Think of it this way--
if you pay taxes now,

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the government gets
the money and they

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get to earn interest on it.

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If you pay taxes next
year, you keep the money

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and you earn interest on it.

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So it's much better
to pay taxes later,

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and that's why these
accounts matter.

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It's a simple example.

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It's a simple example.

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If you have a 30-year account,
if we kept the interest

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rate at 10% and the
tax rate at 25%,

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and did a 30-year
calculation, you

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would have twice as much
money after 30 years,

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if you put it in an IRA
rather than putting it

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in a regular bank account.

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So even though it
eventually gets taxed,

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it's a big advantage.

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It's a big advantage.

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And that's why public policy
introduced these tools--

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401(k)s, pensions, IRAs--
because they're trying

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to encourage saving by
raising the return to saving.

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And they hope that by
encouraging saving,

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they'll get all this good
stuff coming out of it.

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So that's why these
things come up.

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So the first lesson is, just
like my continued nag on you,

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is save early and save often.

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Things like 401(k)s, by
putting your money away,

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not only do you get the
compounding I talked about

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before, but you also get the tax
benefit of paying taxes later

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rather than sooner.

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You get the compounding
on the money

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and the compounding
on the taxes.

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So these kinds of retirement
accounts, when you get your job

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and you're thinking about why
would I worry about retirement,

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worry about retirement.

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There's a big advantage.

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Then you ask, that's
fine, John, but when

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I get my 401(k) paperwork,
I've got like a million things

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I could invest in.

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What I do with the money?

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00:10:38,408 --> 00:10:39,950
So let's talk for
a couple of minutes

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about investment strategy, about
what you do with the money.

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So let's think about
three different ways

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you can invest your retirement
money, three class of options

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a 401(k) will typically have.

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They'll typically be a money
market fund, a bond fund,

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and a stock fund.

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00:11:05,230 --> 00:11:07,230
And there will be various
combinations of these,

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but these are the categories.

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What do these mean?

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Money market means the money is
invested in government bonds.

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00:11:16,787 --> 00:11:18,870
The money is invested in
what are called "Treasury

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00:11:18,870 --> 00:11:21,850
securities," government bonds.

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These are things which are ultra
safe, as long as the US doesn't

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default on its debt, which
we've never done in our history

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and, the good Lord willing,
won't do in the near term.

250
00:11:32,860 --> 00:11:36,520
Because the US doesn't default
on its debt, you get paid back.

251
00:11:36,520 --> 00:11:40,240
These are super safe, the safest
place you can put your money.

252
00:11:40,240 --> 00:11:42,972
But they pay a very
low interest rate.

253
00:11:42,972 --> 00:11:44,680
Right now, they're
paying interest rates,

254
00:11:44,680 --> 00:11:46,480
a typical government
bond fund right now

255
00:11:46,480 --> 00:11:52,270
would be paying interest rate
of around maybe 2%, maybe

256
00:11:52,270 --> 00:11:53,840
1% to 2%--

257
00:11:53,840 --> 00:11:55,975
very low interest
rate, maybe up to 3%

258
00:11:55,975 --> 00:12:00,820
now, but very, very low single
digits, but totally safe.

259
00:12:00,820 --> 00:12:06,280
A bond fund invests your
money in corporate bonds.

260
00:12:06,280 --> 00:12:09,488
Basically, this is making
loans to corporations.

261
00:12:09,488 --> 00:12:11,280
Instead of loaning
money to the government,

262
00:12:11,280 --> 00:12:14,053
you loan the money
to a corporation.

263
00:12:14,053 --> 00:12:15,720
You're not actually
buying a bond in GM.

264
00:12:15,720 --> 00:12:16,810
That's too hard.

265
00:12:16,810 --> 00:12:19,080
So what these 401(k)
accounts do is they say,

266
00:12:19,080 --> 00:12:20,580
we're going to buy
a bunch of bonds.

267
00:12:20,580 --> 00:12:22,288
We're going to put
them together, and let

268
00:12:22,288 --> 00:12:24,490
you own a small piece of
that entire set of bonds.

269
00:12:24,490 --> 00:12:26,730
That's what a bond fund is.

270
00:12:26,730 --> 00:12:29,770
So you own a small piece of
bunch of corporate bonds.

271
00:12:29,770 --> 00:12:31,550
The difference is,
unlike the government,

272
00:12:31,550 --> 00:12:34,920
corporations do go out
of business all the time.

273
00:12:34,920 --> 00:12:37,560
So these are riskier.

274
00:12:37,560 --> 00:12:41,720
These are riskier, but they
pay a higher interest rate.

275
00:12:41,720 --> 00:12:44,150
Bond funds typically
paying 4% to 5% right now.

276
00:12:46,405 --> 00:12:48,655
Then finally, the last thing
you can do with the money

277
00:12:48,655 --> 00:12:50,260
is you can put in stocks.

278
00:12:50,260 --> 00:12:53,470
You could literally
own corporate equity.

279
00:12:53,470 --> 00:12:56,740
You could own a
piece of companies.

280
00:12:56,740 --> 00:12:59,490
You could own a piece
of the companies,

281
00:12:59,490 --> 00:13:03,070
and then what you get
is you get something,

282
00:13:03,070 --> 00:13:04,145
it doesn't really matter.

283
00:13:04,145 --> 00:13:05,520
With these two,
it only matters--

284
00:13:05,520 --> 00:13:07,750
you get paid as long as the
government or the company

285
00:13:07,750 --> 00:13:09,120
doesn't go out of business.

286
00:13:09,120 --> 00:13:12,670
Here you get paid in proportion
to how well the company does.

287
00:13:12,670 --> 00:13:15,150
If it does really well,
you make a lot of money.

288
00:13:15,150 --> 00:13:16,505
Stock prices go up.

289
00:13:16,505 --> 00:13:17,880
If it goes badly,
you lose money.

290
00:13:17,880 --> 00:13:20,325
It goes bankrupt,
you lose everything.

291
00:13:20,325 --> 00:13:21,950
So similar to these,
in the bankruptcy,

292
00:13:21,950 --> 00:13:22,970
it costs you everything.

293
00:13:22,970 --> 00:13:24,980
The difference is these,
either you get paid

294
00:13:24,980 --> 00:13:25,910
or you go bankrupt.

295
00:13:25,910 --> 00:13:27,890
Here, it's much more variable.

296
00:13:27,890 --> 00:13:29,570
Things do well, you get more.

297
00:13:29,570 --> 00:13:31,140
Things go badly, you get less.

298
00:13:31,140 --> 00:13:33,380
So this is the
riskiest option of all,

299
00:13:33,380 --> 00:13:36,930
but it also pays the
highest rate of return.

300
00:13:36,930 --> 00:13:40,050
Traditionally, stock investments
pay a long rate of return

301
00:13:40,050 --> 00:13:43,498
about 7% a year.

302
00:13:43,498 --> 00:13:45,540
So what we see here when
we compare these is what

303
00:13:45,540 --> 00:13:51,950
economists call the
"risk-return trade-off."

304
00:13:57,800 --> 00:14:02,190
The riskier things
are, the higher

305
00:14:02,190 --> 00:14:05,610
you earn by investing
in them, but the riskier

306
00:14:05,610 --> 00:14:06,360
that earnings is.

307
00:14:06,360 --> 00:14:07,860
The more [INAUDIBLE]
invest in them,

308
00:14:07,860 --> 00:14:10,530
but the riskier
that earnings is.

309
00:14:10,530 --> 00:14:14,190
That in other words, people
are willing to accept a lower

310
00:14:14,190 --> 00:14:16,200
interest rate for
a safe investment

311
00:14:16,200 --> 00:14:19,570
than they want for
a risky investment.

312
00:14:19,570 --> 00:14:22,780
And we'll talk about, in
two lectures from now,

313
00:14:22,780 --> 00:14:25,035
why that is, why people's
preferences are that way.

314
00:14:25,035 --> 00:14:27,160
It's because people are
what we call "risk averse."

315
00:14:27,160 --> 00:14:28,535
People don't like
risk, and we'll

316
00:14:28,535 --> 00:14:32,720
talk about why that's
a natural way to be.

317
00:14:32,720 --> 00:14:36,740
So basically, that is
your set of choices.

318
00:14:36,740 --> 00:14:40,700
And what economists
recommend is that the key

319
00:14:40,700 --> 00:14:44,180
in all of these investments
is to diversify.

320
00:14:44,180 --> 00:14:45,860
The key recommendation
of economists

321
00:14:45,860 --> 00:14:54,180
is diversification, that
you spread your money

322
00:14:54,180 --> 00:14:56,910
across these options to get
the right balance of risk

323
00:14:56,910 --> 00:14:59,860
and return.

324
00:14:59,860 --> 00:15:04,693
So that basically, if
you're someone who--

325
00:15:04,693 --> 00:15:06,860
now, how you balance depends
on your taste for risk.

326
00:15:06,860 --> 00:15:08,277
For someone who
really hates risk,

327
00:15:08,277 --> 00:15:09,910
you put most of your money here.

328
00:15:09,910 --> 00:15:12,160
But it's silly to put all
your money in money markets,

329
00:15:12,160 --> 00:15:13,930
because you're losing
a lot of return.

330
00:15:13,930 --> 00:15:15,430
If you're someone
who's risk loving,

331
00:15:15,430 --> 00:15:17,380
you might want to put most
of your money in stocks.

332
00:15:17,380 --> 00:15:18,797
But still don't
put all your money

333
00:15:18,797 --> 00:15:21,040
in stocks, because you
have a much higher risk.

334
00:15:21,040 --> 00:15:23,180
You want some safety
behind you as well.

335
00:15:23,180 --> 00:15:26,690
So an economist would
say you should diversify.

336
00:15:26,690 --> 00:15:27,860
Now, that's a general.

337
00:15:27,860 --> 00:15:31,213
I can't tell you what percentage
is the right percentages.

338
00:15:31,213 --> 00:15:32,380
I can tell you to diversify.

339
00:15:32,380 --> 00:15:36,180
But I can give you one
specific piece of advice--

340
00:15:36,180 --> 00:15:38,890
that when you go
work for Company X,

341
00:15:38,890 --> 00:15:41,530
the one thing you
do not want to do

342
00:15:41,530 --> 00:15:44,850
is put your money in
the stock of Company X.

343
00:15:44,850 --> 00:15:47,590
Why is that?

344
00:15:47,590 --> 00:15:49,090
Why is the last
thing you want to do

345
00:15:49,090 --> 00:15:52,420
when you go to work for Company
X to put a bunch of your money

346
00:15:52,420 --> 00:15:54,580
in the stock of Company X?

347
00:15:54,580 --> 00:15:55,192
Yeah.

348
00:15:55,192 --> 00:15:56,670
AUDIENCE: [INAUDIBLE]

349
00:15:56,670 --> 00:15:58,570
JONATHAN GRUBER:
No, this would be

350
00:15:58,570 --> 00:16:00,070
through a 401(k) [INAUDIBLE].

351
00:16:00,070 --> 00:16:01,140
It wouldn't be like that.

352
00:16:01,140 --> 00:16:01,692
Yeah.

353
00:16:01,692 --> 00:16:04,498
AUDIENCE: If you lose your job,
or if the company shuts down,

354
00:16:04,498 --> 00:16:06,250
you can lose both your
job and the money.

355
00:16:06,250 --> 00:16:09,850
JONATHAN GRUBER: That is the
maximally risky strategy,

356
00:16:09,850 --> 00:16:12,610
because you are tying your
risk of your investments

357
00:16:12,610 --> 00:16:15,600
to your risk of your salary.

358
00:16:15,600 --> 00:16:19,270
That's the most risky
thing you can do.

359
00:16:19,270 --> 00:16:22,210
So absolutely what you
would not want to do

360
00:16:22,210 --> 00:16:23,710
is go work for
Google and say, good,

361
00:16:23,710 --> 00:16:26,010
I'm going to put all my
retirement in Google stock.

362
00:16:26,010 --> 00:16:28,480
You might think Googles
safe, but safer companies

363
00:16:28,480 --> 00:16:29,068
than Google--

364
00:16:29,068 --> 00:16:31,360
companies thought to be safer
than Google at some point

365
00:16:31,360 --> 00:16:32,770
have gone bankrupt.

366
00:16:32,770 --> 00:16:35,770
Google is bankrupt,
you're totally screwed.

367
00:16:35,770 --> 00:16:37,997
You've lost all your
savings and your job,

368
00:16:37,997 --> 00:16:39,580
so the last thing
you want do is that.

369
00:16:39,580 --> 00:16:41,606
Yeah.

370
00:16:41,606 --> 00:16:43,876
AUDIENCE: If you're in a
more corporate position,

371
00:16:43,876 --> 00:16:46,022
and they gave you
bonds as promises.

372
00:16:46,022 --> 00:16:48,480
JONATHAN GRUBER: Well, I mean,
certainly a lot of companies

373
00:16:48,480 --> 00:16:50,563
give you stock options,
where you're sort of stuck

374
00:16:50,563 --> 00:16:51,870
in the stock of that company.

375
00:16:51,870 --> 00:16:53,250
And my lesson there
would be, that's

376
00:16:53,250 --> 00:16:55,375
part of the conversation,
but as soon as it's best,

377
00:16:55,375 --> 00:16:57,440
sell it and get out.

378
00:16:57,440 --> 00:16:59,040
That doesn't mean
you shouldn't--

379
00:16:59,040 --> 00:17:01,040
you should value-- it's
not saying stock options

380
00:17:01,040 --> 00:17:02,440
in the company are worthless.

381
00:17:02,440 --> 00:17:03,440
They're worth something.

382
00:17:03,440 --> 00:17:05,390
It's just they're worth less
than if they just gave you

383
00:17:05,390 --> 00:17:06,930
the cash, because
if you got the cash,

384
00:17:06,930 --> 00:17:08,430
you'd go invest it
in somewhere that

385
00:17:08,430 --> 00:17:10,770
wouldn't be tied to your job.

386
00:17:10,770 --> 00:17:13,829
And this came to a head with
the example of Enron, which

387
00:17:13,829 --> 00:17:15,589
is sort of before your time.

388
00:17:15,589 --> 00:17:17,069
That's sort of when
you were young.

389
00:17:17,069 --> 00:17:20,460
But basically, Enron
was an energy company

390
00:17:20,460 --> 00:17:23,490
that got into some
really shady dealings

391
00:17:23,490 --> 00:17:26,194
to try to essentially
prop up its stock price.

392
00:17:26,194 --> 00:17:28,319
To make itself look valuable
it essentially created

393
00:17:28,319 --> 00:17:31,410
shell companies that were the
same company it sold to them.

394
00:17:31,410 --> 00:17:33,535
So it looked like it was
generating a lot of sales,

395
00:17:33,535 --> 00:17:35,280
but it was just
selling to itself.

396
00:17:35,280 --> 00:17:37,500
It was illegal activity.

397
00:17:37,500 --> 00:17:40,140
But it caused their stock
price to go through the roof.

398
00:17:40,140 --> 00:17:43,195
And Enron, in order to have
enough money in the company,

399
00:17:43,195 --> 00:17:45,570
encouraged their employees to
invest all their retirement

400
00:17:45,570 --> 00:17:46,530
savings at Enron.

401
00:17:46,530 --> 00:17:49,380
Indeed, the Enron
401(k) said, we'll

402
00:17:49,380 --> 00:17:50,950
give you extra money
in your account

403
00:17:50,950 --> 00:17:53,083
if you invest your
money in Enron.

404
00:17:53,083 --> 00:17:55,250
So most people at Enron had
their retirement savings

405
00:17:55,250 --> 00:17:56,600
invested in Enron.

406
00:17:56,600 --> 00:17:59,750
When the whole thing-- and Enron
was a very successful company,

407
00:17:59,750 --> 00:18:01,592
in the Fortune 500,
doing quite well.

408
00:18:01,592 --> 00:18:03,800
When the whole thing collapsed,
these people not only

409
00:18:03,800 --> 00:18:07,470
lost their jobs, they
lost their entire savings.

410
00:18:07,470 --> 00:18:09,900
That's the problem with
non-diversification.

411
00:18:09,900 --> 00:18:11,733
And the ultimate form
of non-diversification

412
00:18:11,733 --> 00:18:14,640
is to invest in the
company you're working for.

413
00:18:14,640 --> 00:18:16,708
Have I scared you enough?

414
00:18:16,708 --> 00:18:17,750
Any questions about that?

415
00:18:20,348 --> 00:18:21,140
Now, let's move on.

416
00:18:21,140 --> 00:18:22,970
That finishes our
discussion of savings.

417
00:18:22,970 --> 00:18:25,250
Let's move on to a
totally new topic, which

418
00:18:25,250 --> 00:18:27,990
we'll talk about this lecture
and the rest of next lecture,

419
00:18:27,990 --> 00:18:29,810
which is international trade.

420
00:18:29,810 --> 00:18:32,720
And let's start with what
is international trade

421
00:18:32,720 --> 00:18:34,928
and why the ruckus?

422
00:18:34,928 --> 00:18:36,470
This is the great
time to be teaching

423
00:18:36,470 --> 00:18:38,220
on international trade,
probably the best,

424
00:18:38,220 --> 00:18:40,943
most exciting time of any year
I've ever taught this topic.

425
00:18:40,943 --> 00:18:42,860
It's front and center
in a way it hasn't been,

426
00:18:42,860 --> 00:18:45,990
probably, in decades.

427
00:18:45,990 --> 00:18:49,220
So what's the big deal?

428
00:18:49,220 --> 00:18:51,270
Let's talk about
a simple example.

429
00:18:51,270 --> 00:18:53,817
How many people have
ever given someone roses

430
00:18:53,817 --> 00:18:54,650
for Valentine's Day?

431
00:18:57,170 --> 00:18:59,310
Raise your hands.

432
00:18:59,310 --> 00:19:05,800
MIT, man-- that's OK, when I
was your age, I hadn't either.

433
00:19:05,800 --> 00:19:08,260
Now, here's the interesting
problem with Valentine's Day--

434
00:19:08,260 --> 00:19:11,090
Valentine's Day
falls in the winter.

435
00:19:11,090 --> 00:19:14,540
Roses don't grow outside
in the cold in the winter.

436
00:19:14,540 --> 00:19:15,500
So what do you do?

437
00:19:15,500 --> 00:19:17,660
For many years,
what we did was we

438
00:19:17,660 --> 00:19:20,390
had hot houses where we grew--

439
00:19:20,390 --> 00:19:23,810
basically were dedicated,
their reason for existing,

440
00:19:23,810 --> 00:19:26,600
was essentially to grow
Valentine's Day roses.

441
00:19:26,600 --> 00:19:29,210
So it's an industry around
growing these indoor roses

442
00:19:29,210 --> 00:19:33,270
in the winter so that you
could have them available.

443
00:19:33,270 --> 00:19:35,250
But what happened over
time is we realized

444
00:19:35,250 --> 00:19:38,730
it was a lot cheaper to actually
by the roses in Colombia

445
00:19:38,730 --> 00:19:41,060
or countries like
that, and fly them up,

446
00:19:41,060 --> 00:19:43,690
than to actually
have them grown here.

447
00:19:43,690 --> 00:19:45,960
So what happened
was all the roses

448
00:19:45,960 --> 00:19:50,220
we get now in the winter
come from South America.

449
00:19:50,220 --> 00:19:53,640
And we don't grow roses in
America anymore in the winter.

450
00:19:53,640 --> 00:19:56,700
So is that a good
thing or a bad thing?

451
00:19:56,700 --> 00:19:59,220
Well, on the one hand, roses
are a ton cheaper now than

452
00:19:59,220 --> 00:20:02,087
when I was a kid.

453
00:20:02,087 --> 00:20:04,170
So that's a good thing for
the romantics among us.

454
00:20:04,170 --> 00:20:06,475
You can get a dozen
roses for 25 bucks.

455
00:20:06,475 --> 00:20:08,600
It was like 80 bucks when
I was a kid or something.

456
00:20:08,600 --> 00:20:11,140
It was crazy.

457
00:20:11,140 --> 00:20:12,640
On the other hand,
a bunch of guys

458
00:20:12,640 --> 00:20:15,040
who used to grow these
roses are out of jobs.

459
00:20:15,040 --> 00:20:18,370
There was an industry devoted
to growing these roses

460
00:20:18,370 --> 00:20:20,500
and these people
now have no job,

461
00:20:20,500 --> 00:20:23,190
because they're
grown somewhere else.

462
00:20:23,190 --> 00:20:24,770
So how do we think about--

463
00:20:24,770 --> 00:20:28,100
this trade-off is sort of a
microcosm of the larger debate

464
00:20:28,100 --> 00:20:30,290
around international trade.

465
00:20:30,290 --> 00:20:32,930
The larger debate about
whether trade is good or bad

466
00:20:32,930 --> 00:20:35,610
comes down to this rose example.

467
00:20:35,610 --> 00:20:38,810
It sort of summarizes
that issue.

468
00:20:38,810 --> 00:20:40,810
So now, when we think
about international trade,

469
00:20:40,810 --> 00:20:42,640
we think about three concepts.

470
00:20:42,640 --> 00:20:47,730
We think about
exports, which are

471
00:20:47,730 --> 00:20:53,430
the amount of goods that
we sell to other countries,

472
00:20:53,430 --> 00:20:58,260
and imports, which are the
amount of goods that we

473
00:20:58,260 --> 00:21:00,480
buy from other countries.

474
00:21:00,480 --> 00:21:02,360
So a country exports
to other countries.

475
00:21:02,360 --> 00:21:05,330
It imports from other countries.

476
00:21:05,330 --> 00:21:12,280
Currently, the US exports about
$1.6 trillion of goods a year.

477
00:21:12,280 --> 00:21:18,320
That's trillion with a T. It
imports about $2.4 trillion

478
00:21:18,320 --> 00:21:27,800
of goods a year, leaving us with
an $800 billion trade deficit.

479
00:21:27,800 --> 00:21:31,930
You may have heard the President
mention this once or twice--

480
00:21:31,930 --> 00:21:36,080
an $800 billion trade deficit.

481
00:21:36,080 --> 00:21:41,070
So the question you want to ask
is, how big a problem is this

482
00:21:41,070 --> 00:21:42,450
that we have a trade deficit?

483
00:21:42,450 --> 00:21:46,290
And the answer economists
give is none problem.

484
00:21:46,290 --> 00:21:46,790
No?

485
00:21:46,790 --> 00:21:47,960
No Spinal Tap fans here?

486
00:21:47,960 --> 00:21:51,020
OK, whatever.

487
00:21:51,020 --> 00:21:56,040
So basically, let's explain
this in a simple example.

488
00:21:56,040 --> 00:22:00,020
Imagine that you
have two Pikachus

489
00:22:00,020 --> 00:22:04,020
and your friend has
two Jigglypuffs.

490
00:22:04,020 --> 00:22:08,130
And you want to have a more
diverse set of Pokemon,

491
00:22:08,130 --> 00:22:10,620
so you go to your
friend and you say,

492
00:22:10,620 --> 00:22:14,970
I will trade you one
Pikachu for one Jigglypuff.

493
00:22:14,970 --> 00:22:17,040
So you send your
friend a Pikachu.

494
00:22:17,040 --> 00:22:19,120
He sends you a Jigglypuff.

495
00:22:19,120 --> 00:22:23,190
You've just created a
massive Pikachu deficit.

496
00:22:23,190 --> 00:22:25,650
Think about it-- you used
to have two Pikachus.

497
00:22:25,650 --> 00:22:27,210
You sent one away.

498
00:22:27,210 --> 00:22:28,530
You sent one away.

499
00:22:28,530 --> 00:22:31,170
You didn't get any
Pikachus back, did you?

500
00:22:31,170 --> 00:22:35,230
So you've created a huge
deficit of one Pikachu.

501
00:22:35,230 --> 00:22:36,760
Is that bad?

502
00:22:36,760 --> 00:22:38,788
No, you got a Jigglypuff.

503
00:22:38,788 --> 00:22:39,330
You're happy.

504
00:22:39,330 --> 00:22:40,538
You wanted to make the trade.

505
00:22:40,538 --> 00:22:42,310
You made the trade.

506
00:22:42,310 --> 00:22:44,268
Calling the trade deficit,
define trade deficit

507
00:22:44,268 --> 00:22:46,018
in terms of-- if you
define trade deficit,

508
00:22:46,018 --> 00:22:47,470
instead, in terms
of Jigglypuffs,

509
00:22:47,470 --> 00:22:49,705
you've got a huge trade surplus.

510
00:22:49,705 --> 00:22:53,220
You used to get no
Jigglypuffs, now you get one.

511
00:22:53,220 --> 00:22:55,710
So basically, a trade
deficit, trade surplus,

512
00:22:55,710 --> 00:22:57,480
is all about an
arbitrary definition.

513
00:22:57,480 --> 00:23:01,170
The bottom line is America
then spends $800 billion more.

514
00:23:01,170 --> 00:23:03,360
You're sending money
to other countries,

515
00:23:03,360 --> 00:23:06,990
but we get $800 billion
year more stuff for it.

516
00:23:06,990 --> 00:23:08,730
There's no bad or good.

517
00:23:08,730 --> 00:23:11,790
It's just the way trade works.

518
00:23:11,790 --> 00:23:14,825
So any time you've had a trade
in your life of anything,

519
00:23:14,825 --> 00:23:16,200
with a friend or
whatever, you've

520
00:23:16,200 --> 00:23:19,360
created a deficit and a surplus.

521
00:23:19,360 --> 00:23:21,880
But that doesn't mean anyone
is worse off or better off.

522
00:23:21,880 --> 00:23:23,463
Whether you're worse
off or better off

523
00:23:23,463 --> 00:23:27,400
depends on the indicators of
the trade, depends on how much

524
00:23:27,400 --> 00:23:31,360
each party values
what's going on.

525
00:23:31,360 --> 00:23:34,095
So basically, if I
said, oh, good Lord,

526
00:23:34,095 --> 00:23:37,090
if I had a headline like, "Good
Lord, Gruber Trades Pikachu

527
00:23:37,090 --> 00:23:42,420
Deficit, Must End Trade
with Jigglypuff Land,"

528
00:23:42,420 --> 00:23:45,110
we must shut down trade,
because good Lord,

529
00:23:45,110 --> 00:23:50,040
we're creating this huge Pikachu
deficit, that would be bad.

530
00:23:50,040 --> 00:23:53,670
Because I wanted to trade
my Pikachu for a Jigglypuff

531
00:23:53,670 --> 00:23:54,420
I was happier.

532
00:23:56,940 --> 00:23:59,370
That would be a bad
thing to shut that off.

533
00:23:59,370 --> 00:24:02,060
And that, in a stupid
example, is why economists

534
00:24:02,060 --> 00:24:04,810
like international trade.

535
00:24:04,810 --> 00:24:07,178
It's the same reason we
like trade in general.

536
00:24:07,178 --> 00:24:08,470
Think about this whole course--

537
00:24:08,470 --> 00:24:10,660
the whole course is
a bit about trade.

538
00:24:10,660 --> 00:24:13,690
It's about trading our
money for cookies and pizza,

539
00:24:13,690 --> 00:24:17,800
about trading a firm's money
for workers and machines,

540
00:24:17,800 --> 00:24:20,940
about trading my
time for a wage.

541
00:24:20,940 --> 00:24:22,403
Life is all about trades.

542
00:24:22,403 --> 00:24:24,570
International trade is just
another example of that.

543
00:24:24,570 --> 00:24:26,695
Just because it's got this
bizarre label of a trade

544
00:24:26,695 --> 00:24:29,930
deficit, we think
about it differently.

545
00:24:29,930 --> 00:24:34,190
So that's sort of basically,
if you think about-- now

546
00:24:34,190 --> 00:24:35,900
let's replace Pikachus
and Jigglypuffs

547
00:24:35,900 --> 00:24:38,920
with the US and a poor country.

548
00:24:38,920 --> 00:24:41,170
Instead of US
having two Pikachus,

549
00:24:41,170 --> 00:24:43,420
the US has tons of money.

550
00:24:43,420 --> 00:24:45,940
Instead of the poor country
having two Jigglypuffs,

551
00:24:45,940 --> 00:24:49,720
the poor country has really
underpaid workers who

552
00:24:49,720 --> 00:24:52,803
can make stuff really cheaply.

553
00:24:52,803 --> 00:24:53,970
So I, in the US, say, wait--

554
00:24:53,970 --> 00:24:55,260
I have a lot of money.

555
00:24:55,260 --> 00:24:56,970
You've got a lot of sweaters.

556
00:24:56,970 --> 00:24:59,840
I'm going to send you my
money and get your sweaters.

557
00:24:59,840 --> 00:25:01,640
I'm better off because
I was happy to buy

558
00:25:01,640 --> 00:25:02,878
those sweaters cheaply.

559
00:25:02,878 --> 00:25:04,920
You're better off because
you can't eat sweaters.

560
00:25:04,920 --> 00:25:07,400
You need money, so you
get some of my money.

561
00:25:07,400 --> 00:25:10,010
We're both better off, but
I've created a trade deficit.

562
00:25:12,860 --> 00:25:15,650
That is not
inherently a problem.

563
00:25:15,650 --> 00:25:19,500
Now of course, the reality
is more complicated.

564
00:25:19,500 --> 00:25:22,940
The reality is that when I send
the money to those countries

565
00:25:22,940 --> 00:25:25,190
to buy the sweaters, and
I bring the sweaters in,

566
00:25:25,190 --> 00:25:28,010
my consumers of sweaters
are much happier.

567
00:25:28,010 --> 00:25:31,010
And I keep focusing on sweaters
because it's just amazing.

568
00:25:31,010 --> 00:25:35,150
This sweater I just
got at Old Navy, $15.

569
00:25:35,150 --> 00:25:38,110
Pretty nice, decent, it's
not cotton, whatever.

570
00:25:38,110 --> 00:25:38,900
$15.

571
00:25:38,900 --> 00:25:42,290
This would have been a
fortune when I was your age.

572
00:25:42,290 --> 00:25:44,830
In those day's dollars,
it would've been $30,

573
00:25:44,830 --> 00:25:47,940
and that would be
like $70 today.

574
00:25:47,940 --> 00:25:48,600
Why?

575
00:25:48,600 --> 00:25:51,130
China.

576
00:25:51,130 --> 00:25:54,340
Because we used these to
make these in North Carolina,

577
00:25:54,340 --> 00:25:57,630
now we make them in China.

578
00:25:57,630 --> 00:25:59,930
So the good news is,
I went to Old Navy,

579
00:25:59,930 --> 00:26:04,700
I got two pairs of pants, and
like four sweaters, like $100.

580
00:26:04,700 --> 00:26:06,440
That's the good news.

581
00:26:06,440 --> 00:26:09,560
The bad news is the guys in
North Carolina lost their jobs.

582
00:26:09,560 --> 00:26:11,420
That's the bad news.

583
00:26:11,420 --> 00:26:13,260
So there's a trade-off.

584
00:26:13,260 --> 00:26:16,530
Now, I'm going to argue over
the next lecture and a half

585
00:26:16,530 --> 00:26:18,928
that that trade-off is
worth it in aggregate,

586
00:26:18,928 --> 00:26:20,970
but we can't ignore the
fact there's a trade-off.

587
00:26:20,970 --> 00:26:24,570
Because that's what leads
to the very intense debates

588
00:26:24,570 --> 00:26:28,410
around international trade,
is the fundamental tension

589
00:26:28,410 --> 00:26:30,960
between the consumers
of goods that

590
00:26:30,960 --> 00:26:33,090
are made cheaper by
international trade

591
00:26:33,090 --> 00:26:34,980
and the producers
of goods that get

592
00:26:34,980 --> 00:26:38,010
wiped out by
international trade.

593
00:26:38,010 --> 00:26:39,150
So that's our setup.

594
00:26:39,150 --> 00:26:40,230
That's our big picture.

595
00:26:40,230 --> 00:26:41,220
Now I'm going to
dive in, and I'm

596
00:26:41,220 --> 00:26:42,970
going to teach you the
nitty gritty of how

597
00:26:42,970 --> 00:26:45,510
we think about this with models,
but that's the big picture

598
00:26:45,510 --> 00:26:46,780
I wanted you to have in mind.

599
00:26:46,780 --> 00:26:48,030
So let's dive into the models.

600
00:26:48,030 --> 00:26:50,640
And to do the models, I
need to introduce a new tool

601
00:26:50,640 --> 00:26:53,910
to you, which is the
Production Possibility

602
00:26:53,910 --> 00:26:57,400
Frontier, the PPF, the
Production Possibility

603
00:26:57,400 --> 00:26:57,900
Frontier.

604
00:27:00,910 --> 00:27:08,020
What the PPF shows you is the
maximum combination of outputs

605
00:27:08,020 --> 00:27:10,540
you can produce for any
given set of inputs.

606
00:27:14,030 --> 00:27:16,658
So basically, let's
think about that.

607
00:27:16,658 --> 00:27:18,200
Let's go to figure
18.2, because it's

608
00:27:18,200 --> 00:27:19,820
easy to see this graphically.

609
00:27:19,820 --> 00:27:24,460
Let's go to figure 18.2.

610
00:27:24,460 --> 00:27:27,400
Let's think of you as a firm.

611
00:27:27,400 --> 00:27:31,330
And you as a firm
produce two things--

612
00:27:31,330 --> 00:27:34,210
problem set points
and exam points.

613
00:27:34,210 --> 00:27:36,250
Sorry, it's all you're
good for at MIT here.

614
00:27:36,250 --> 00:27:38,920
You produce problem set
points and exam points,

615
00:27:38,920 --> 00:27:40,540
but you can produce either.

616
00:27:40,540 --> 00:27:42,670
Those are the two
things you produce.

617
00:27:42,670 --> 00:27:46,300
And to make life easy, let's say
given your innate intelligence,

618
00:27:46,300 --> 00:27:48,587
the points are produced
as a function of time.

619
00:27:48,587 --> 00:27:50,920
Literally the more time you
put in studying for an exam,

620
00:27:50,920 --> 00:27:53,503
the better you do, the more time
you spend on the problem set,

621
00:27:53,503 --> 00:27:54,660
the better you do.

622
00:27:54,660 --> 00:27:57,920
And you have one scarce
input, which is time.

623
00:27:57,920 --> 00:27:59,450
This production
possibility frontier

624
00:27:59,450 --> 00:28:01,340
tells you if you devote
your scarce input

625
00:28:01,340 --> 00:28:03,980
across different activities,
what will the result be

626
00:28:03,980 --> 00:28:05,570
in terms of what's produced.

627
00:28:05,570 --> 00:28:07,730
So what's this line saying
on the left-hand side?

628
00:28:07,730 --> 00:28:13,040
It's saying, if I put all my
time into studying for exams,

629
00:28:13,040 --> 00:28:16,960
I'll get 200 points on
exams and 0 on problem sets.

630
00:28:16,960 --> 00:28:20,140
If I spend all my time
doing problem sets,

631
00:28:20,140 --> 00:28:22,780
I'll got 200 points of
problem sets and 0 on exams,

632
00:28:22,780 --> 00:28:25,030
and some combinations
in between.

633
00:28:25,030 --> 00:28:28,600
That is a production
possibility frontier.

634
00:28:28,600 --> 00:28:30,650
It shows the
combination of output

635
00:28:30,650 --> 00:28:35,430
you get for any given
fixed level of inputs.

636
00:28:35,430 --> 00:28:38,870
Now, what is wrong with
the graph on the left?

637
00:28:38,870 --> 00:28:42,410
And why is the graph on the
right a probably more realistic

638
00:28:42,410 --> 00:28:45,147
description of what your
actual production possibility

639
00:28:45,147 --> 00:28:45,980
frontier looks like?

640
00:28:49,920 --> 00:28:51,169
Yeah.

641
00:28:51,169 --> 00:28:53,711
AUDIENCE: You know, if you can
get more points on the problem

642
00:28:53,711 --> 00:28:55,421
set, and you know more, you're
probably more well prepared

643
00:28:55,421 --> 00:28:56,220
for the exam.

644
00:28:56,220 --> 00:28:57,137
JONATHAN GRUBER: Yeah.

645
00:28:57,137 --> 00:28:59,460
It's wrong because in
fact, what this system

646
00:28:59,460 --> 00:29:03,110
features is something we
call "economies of scope."

647
00:29:03,110 --> 00:29:06,020
We talked about economies of
scale a number of lectures ago,

648
00:29:06,020 --> 00:29:09,740
the notion that if you double
inputs, you double output.

649
00:29:09,740 --> 00:29:11,540
This is economies
of scope, which

650
00:29:11,540 --> 00:29:15,090
is that by producing more
than one thing at once,

651
00:29:15,090 --> 00:29:18,070
you may get better at both.

652
00:29:18,070 --> 00:29:21,770
By studying for an exam, you
get better at problem sets.

653
00:29:21,770 --> 00:29:25,050
And by doing problem sets,
you do better on the exam.

654
00:29:25,050 --> 00:29:28,070
So what that means is,
doing some of both leads

655
00:29:28,070 --> 00:29:33,360
to a better outcome than doing
all of one or all the other.

656
00:29:33,360 --> 00:29:38,510
You get a concave to
the origin production

657
00:29:38,510 --> 00:29:40,290
possibility frontier.

658
00:29:40,290 --> 00:29:41,780
A concave to the
origin production

659
00:29:41,780 --> 00:29:43,470
possibility frontier
demonstrates

660
00:29:43,470 --> 00:29:45,260
economies of scope.

661
00:29:45,260 --> 00:29:47,913
Doing some of both
is better than

662
00:29:47,913 --> 00:29:49,580
doing all of just one
and all the other.

663
00:29:49,580 --> 00:29:50,955
And that makes
sense for you when

664
00:29:50,955 --> 00:29:52,280
doing problem sets and exams.

665
00:29:52,280 --> 00:29:54,670
It makes sense you'd be
better off doing some of both

666
00:29:54,670 --> 00:29:57,337
than devoting all your attention
to just one and just the other.

667
00:29:59,830 --> 00:30:01,890
So that is a production
possibility frontier.

668
00:30:01,890 --> 00:30:05,350
Now, there can also be
dis-economies of scope.

669
00:30:05,350 --> 00:30:07,100
Another great example
for MIT is that when

670
00:30:07,100 --> 00:30:09,630
I was here as an undergrad,
I came in as a tennis player.

671
00:30:09,630 --> 00:30:11,120
And I was on the tennis team.

672
00:30:11,120 --> 00:30:12,912
Now tennis was only in
the fall and spring.

673
00:30:12,912 --> 00:30:14,240
In the winter, they had squash.

674
00:30:14,240 --> 00:30:16,260
So I thought I'd play squash.

675
00:30:16,260 --> 00:30:18,280
Well, it turns out that
the key with tennis

676
00:30:18,280 --> 00:30:20,480
is keeping your wrist firm,
and the key with squash

677
00:30:20,480 --> 00:30:22,370
is keeping your wrist flexible.

678
00:30:22,370 --> 00:30:24,500
And by playing squash, I
screwed up my tennis game,

679
00:30:24,500 --> 00:30:27,630
and by playing tennis, I
screwed up my squash game.

680
00:30:27,630 --> 00:30:30,090
So I had a dis-economy of scope.

681
00:30:30,090 --> 00:30:33,480
I was worse off at both things
by playing both, rather than

682
00:30:33,480 --> 00:30:36,204
just playing one or the other.

683
00:30:36,204 --> 00:30:38,247
So there can be
economies of scope,

684
00:30:38,247 --> 00:30:40,580
which is when doing both
things make you better at both,

685
00:30:40,580 --> 00:30:43,010
and dis-economies of scope
when doing both things

686
00:30:43,010 --> 00:30:45,200
make you worse at both.

687
00:30:45,200 --> 00:30:47,960
And that's the nature of
the shape of production

688
00:30:47,960 --> 00:30:49,460
possibilities frontier.

689
00:30:49,460 --> 00:30:51,830
An economy of scope
is when doing both

690
00:30:51,830 --> 00:30:52,880
makes you better off.

691
00:30:52,880 --> 00:30:59,270
A dis-economy of scope is when
doing both makes you worse off.

692
00:30:59,270 --> 00:31:02,060
Questions about that?

693
00:31:02,060 --> 00:31:05,160
Now, I just introduced
that tool because that tool

694
00:31:05,160 --> 00:31:08,700
is going to be the fundamental
modeling feature that

695
00:31:08,700 --> 00:31:11,910
allows us to demonstrate
why international trade is

696
00:31:11,910 --> 00:31:14,300
beneficial.

697
00:31:14,300 --> 00:31:16,580
So now, we're going
to take that tool

698
00:31:16,580 --> 00:31:19,760
and we're going to go and
talk about the concept

699
00:31:19,760 --> 00:31:28,000
of comparative
advantage, which is

700
00:31:28,000 --> 00:31:31,240
the core concept in
international trade economics.

701
00:31:31,240 --> 00:31:32,950
This is the core of
how it all works.

702
00:31:35,720 --> 00:31:38,400
Let's think of a particular
example to understand this.

703
00:31:38,400 --> 00:31:42,700
Let's take the US and
Colombia and the rose market.

704
00:31:42,700 --> 00:31:46,690
And as I said before, let's
say it's expensive for the US--

705
00:31:46,690 --> 00:31:48,880
and the Valentine's
Day rose market.

706
00:31:48,880 --> 00:31:51,250
It's expensive for the US to
grow Valentine's Day roses.

707
00:31:51,250 --> 00:31:52,240
It's cheap in Colombia.

708
00:31:55,060 --> 00:31:59,930
On the other hand, let's
compare roses to computers.

709
00:31:59,930 --> 00:32:01,858
Roses are cheap to
produce in Colombia

710
00:32:01,858 --> 00:32:02,900
and expensive in America.

711
00:32:02,900 --> 00:32:04,860
Computers are the opposite.

712
00:32:04,860 --> 00:32:07,130
We have giant factories,
and skilled labor,

713
00:32:07,130 --> 00:32:10,040
and giant machines that can
quickly crank out computers.

714
00:32:10,040 --> 00:32:14,480
In Colombia, they'd have to like
assemble the computer by hand.

715
00:32:14,480 --> 00:32:17,630
So it's a lot cheaper to
produce a computer in the US

716
00:32:17,630 --> 00:32:19,370
than it is in Colombia.

717
00:32:19,370 --> 00:32:21,740
It's a lot cheaper to
produce a rose in Colombia

718
00:32:21,740 --> 00:32:25,020
than it is in the US.

719
00:32:25,020 --> 00:32:27,750
The way to think about
this is through the lens

720
00:32:27,750 --> 00:32:30,710
of opportunity cost.

721
00:32:30,710 --> 00:32:34,040
What we're saying is
the opportunity cost

722
00:32:34,040 --> 00:32:40,612
of making a rose in terms of
computers is higher in the US,

723
00:32:40,612 --> 00:32:43,070
In other words, the amount of
computers you have to give up

724
00:32:43,070 --> 00:32:45,800
to make a rose is high in the
US, because computers are cheap

725
00:32:45,800 --> 00:32:47,910
and roses are expensive.

726
00:32:47,910 --> 00:32:51,440
The amount of roses
you have to give up

727
00:32:51,440 --> 00:32:54,080
to make a computer in
Colombia is higher,

728
00:32:54,080 --> 00:32:56,790
because roses are cheap and
computers are expensive.

729
00:32:56,790 --> 00:33:10,590
So we say that Colombia has a
comparative advantage in roses.

730
00:33:10,590 --> 00:33:14,730
It is relatively cheap-- in a
world of computers and roses,

731
00:33:14,730 --> 00:33:17,280
it is relatively cheap
for them to produce roses

732
00:33:17,280 --> 00:33:18,870
compared to computers.

733
00:33:18,870 --> 00:33:22,770
The opportunity costs in terms
of forgone computers is lower.

734
00:33:22,770 --> 00:33:27,960
Whereas the US has a comparative
advantage in computers.

735
00:33:31,800 --> 00:33:38,340
It is comparatively cheaper
for us to produce computers.

736
00:33:38,340 --> 00:33:41,460
So international trade
is all about what

737
00:33:41,460 --> 00:33:43,913
you're relatively better at.

738
00:33:43,913 --> 00:33:45,830
Now, let me emphasize
"relative" for a second.

739
00:33:45,830 --> 00:33:47,510
This is an important concept.

740
00:33:47,510 --> 00:33:49,200
The reason we don't
just say "advantage"

741
00:33:49,200 --> 00:33:51,290
and we say "comparative
advantage" is it

742
00:33:51,290 --> 00:33:53,590
doesn't actually matter
if you're better.

743
00:33:53,590 --> 00:33:55,315
It matters if you're
relatively better.

744
00:33:55,315 --> 00:33:55,940
Let me explain.

745
00:33:55,940 --> 00:33:57,260
This is hard.

746
00:33:57,260 --> 00:33:59,863
I would say of the main
economics concepts in the world

747
00:33:59,863 --> 00:34:01,280
that we need people
to understand,

748
00:34:01,280 --> 00:34:03,560
this is one of the top three
least understood concepts

749
00:34:03,560 --> 00:34:05,642
in all the world in economics.

750
00:34:05,642 --> 00:34:07,100
[INAUDIBLE] it's
like in our blood,

751
00:34:07,100 --> 00:34:08,719
and we can't understand why
regular people can't understand

752
00:34:08,719 --> 00:34:09,219
it.

753
00:34:09,219 --> 00:34:10,820
It's because it's hard.

754
00:34:10,820 --> 00:34:12,530
Let me give you an example.

755
00:34:12,530 --> 00:34:14,712
Take me and LeBron
James, and imagine

756
00:34:14,712 --> 00:34:16,670
there's two activities
in life, mowing the lawn

757
00:34:16,670 --> 00:34:17,900
and playing basketball.

758
00:34:17,900 --> 00:34:20,360
That's all life consists of.

759
00:34:20,360 --> 00:34:24,980
Now, LeBron James is better than
me at both playing basketball

760
00:34:24,980 --> 00:34:27,219
and mowing the lawn.

761
00:34:27,219 --> 00:34:29,030
But he's much, much,
much, much, much,

762
00:34:29,030 --> 00:34:31,420
much better than me at
basketball and only much

763
00:34:31,420 --> 00:34:34,010
better than me at
mowing the lawn.

764
00:34:34,010 --> 00:34:38,900
So LeBron James has an advantage
in everything, both activities,

765
00:34:38,900 --> 00:34:43,656
but he only has a comparative
advantage in basketball.

766
00:34:43,656 --> 00:34:45,739
He only has a comparative
advantage in basketball.

767
00:34:45,739 --> 00:34:48,560
The comparative advantage
is about opportunity costs.

768
00:34:48,560 --> 00:34:52,699
In other words, if LeBron
James mows his lawn,

769
00:34:52,699 --> 00:34:55,760
the amount of basketball
he's giving up is ungodly.

770
00:34:55,760 --> 00:34:57,425
It's crazy to have
to mow his lawn,

771
00:34:57,425 --> 00:34:59,300
given how much basketball
he could've played.

772
00:34:59,300 --> 00:35:01,467
If I mow my lawn, I'm not
giving up much basketball,

773
00:35:01,467 --> 00:35:03,400
because I suck at basketball.

774
00:35:03,400 --> 00:35:05,872
So I have a comparative
advantage in lawn mowing.

775
00:35:05,872 --> 00:35:08,080
You say, you're not at lawn
mowing than LeBron James.

776
00:35:08,080 --> 00:35:09,100
I'm not.

777
00:35:09,100 --> 00:35:11,650
But I have a comparative
advantage in lawn mowing,

778
00:35:11,650 --> 00:35:15,268
because the opportunity
cost to me is much lower.

779
00:35:15,268 --> 00:35:17,560
The opportunity cost to LeBron
James of mowing his lawn

780
00:35:17,560 --> 00:35:19,750
is high, because he could
be playing basketball.

781
00:35:19,750 --> 00:35:21,190
The opportunity
cost to me is low,

782
00:35:21,190 --> 00:35:23,320
because I can't play basketball.

783
00:35:23,320 --> 00:35:24,313
Yeah.

784
00:35:24,313 --> 00:35:25,730
AUDIENCE: [INAUDIBLE]
the only one

785
00:35:25,730 --> 00:35:28,000
in the world that can mow lawns.

786
00:35:28,000 --> 00:35:29,750
JONATHAN GRUBER: That's
a weird edge case.

787
00:35:29,750 --> 00:35:30,417
I won't do that.

788
00:35:30,417 --> 00:35:32,380
Then there'd be no reason for--

789
00:35:32,380 --> 00:35:34,630
that makes trade things hard.

790
00:35:34,630 --> 00:35:36,100
We can come back to that.

791
00:35:36,100 --> 00:35:39,910
Now of course, the example
doesn't stop there.

792
00:35:39,910 --> 00:35:43,360
Should I mow my lawn?

793
00:35:43,360 --> 00:35:47,290
No, I should not mow
my lawn, because there

794
00:35:47,290 --> 00:35:52,720
is someone who doesn't have
as much education as I, who

795
00:35:52,720 --> 00:35:55,502
can't earn as much
money than I at work.

796
00:35:55,502 --> 00:35:57,710
And they have a comparative
advantage in lawn mowing.

797
00:35:57,710 --> 00:36:00,482
I have a comparative
advantage in office work.

798
00:36:00,482 --> 00:36:01,940
So in fact, not
only should I mow--

799
00:36:01,940 --> 00:36:04,710
do I have comparative advantage
over LeBron in lawn mowing,

800
00:36:04,710 --> 00:36:07,290
but some less-educated guy
has a competitive edge over me

801
00:36:07,290 --> 00:36:09,608
in lawn mowing.

802
00:36:09,608 --> 00:36:11,150
So just as LeBron
would be better off

803
00:36:11,150 --> 00:36:13,233
letting me mow his lawn
and I'm better off letting

804
00:36:13,233 --> 00:36:15,040
him play basketball,
I'm better off

805
00:36:15,040 --> 00:36:18,170
letting some less-educated guy
mow my lawn, and letting me go

806
00:36:18,170 --> 00:36:21,625
sit in front of my
computer all day.

807
00:36:21,625 --> 00:36:23,250
Comparative advantage
is all about what

808
00:36:23,250 --> 00:36:26,210
you're relatively better at.

809
00:36:26,210 --> 00:36:30,740
And the key insight
of international trade

810
00:36:30,740 --> 00:36:34,940
is that in a world of
comparative advantage,

811
00:36:34,940 --> 00:36:38,770
people should always specialize.

812
00:36:38,770 --> 00:36:40,960
In a world of
comparative advantage,

813
00:36:40,960 --> 00:36:43,083
people should always specialize.

814
00:36:43,083 --> 00:36:44,500
You should do what
you're best at.

815
00:36:47,500 --> 00:36:50,290
You should do what you're best
at because otherwise, it's

816
00:36:50,290 --> 00:36:54,002
simply silly for LeBron to
spend any time mowing his lawn.

817
00:36:54,002 --> 00:36:56,460
As much as my wife thinks I'm
just trying to get out of it,

818
00:36:56,460 --> 00:36:59,230
it's simply silly for me to
spend any time mowing my lawn.

819
00:37:01,910 --> 00:37:04,630
I have a comparative advantage
sitting on my computer

820
00:37:04,630 --> 00:37:06,520
and doing that stuff,
so I should hire

821
00:37:06,520 --> 00:37:08,470
someone else to mow my lawn.

822
00:37:08,470 --> 00:37:15,367
So to actually see that,
let's go to figure 18.3.

823
00:37:15,367 --> 00:37:16,784
This is a confusing
figure, so I'm

824
00:37:16,784 --> 00:37:20,450
going to go through it slowly.

825
00:37:20,450 --> 00:37:24,260
On the top, we have the US
production possibilities

826
00:37:24,260 --> 00:37:24,980
frontier.

827
00:37:24,980 --> 00:37:27,020
And to make life
easy, let's assume

828
00:37:27,020 --> 00:37:29,300
that there's no
economies of scope

829
00:37:29,300 --> 00:37:30,850
between roses and computers.

830
00:37:30,850 --> 00:37:32,187
Makes sense there wouldn't be.

831
00:37:32,187 --> 00:37:34,270
Let's assume there's no
economies or dis-economies

832
00:37:34,270 --> 00:37:35,437
between roses and computers.

833
00:37:35,437 --> 00:37:37,523
It's a linear production
possibility frontier.

834
00:37:37,523 --> 00:37:40,190
So we're showing each graph as a
production possibility frontier

835
00:37:40,190 --> 00:37:41,630
between roses and computers.

836
00:37:41,630 --> 00:37:44,990
And we're assuming it's just
linear, which makes sense.

837
00:37:44,990 --> 00:37:48,440
You don't make better computers
by making roses and vice versa.

838
00:37:48,440 --> 00:37:50,420
On the top, we have the US.

839
00:37:50,420 --> 00:37:53,710
Let's say that the US's
production possibility

840
00:37:53,710 --> 00:37:54,890
frontier is the following--

841
00:37:54,890 --> 00:37:57,680
given the resources
we have in the US,

842
00:37:57,680 --> 00:38:03,608
we can produce 2,000 computers
or 1,000 boxes of roses, given

843
00:38:03,608 --> 00:38:05,400
our resources, our
skill level, our capital

844
00:38:05,400 --> 00:38:08,090
intensity, et cetera.

845
00:38:08,090 --> 00:38:10,230
Now go to Colombia.

846
00:38:10,230 --> 00:38:14,040
Say that Colombia, given
their skill level, resources,

847
00:38:14,040 --> 00:38:16,570
the sunshine, the
beautiful weather--

848
00:38:16,570 --> 00:38:18,630
any Colombians here?

849
00:38:18,630 --> 00:38:19,290
Sounds perfect.

850
00:38:19,290 --> 00:38:20,470
It's like 75 all the time.

851
00:38:23,160 --> 00:38:27,240
They can make 2,000 roses
and 1,000 computers,

852
00:38:27,240 --> 00:38:30,590
or 1,000 computers, or some
combination in between.

853
00:38:30,590 --> 00:38:32,875
So the first thing I want
to make you guys understand

854
00:38:32,875 --> 00:38:35,000
is why these are sensible
production possibility

855
00:38:35,000 --> 00:38:36,278
frontiers for each country.

856
00:38:36,278 --> 00:38:38,320
They're sensible production
possibility frontiers

857
00:38:38,320 --> 00:38:43,810
because they basically show the
US has a comparative advantage

858
00:38:43,810 --> 00:38:45,760
in computers.

859
00:38:45,760 --> 00:38:47,950
That is, the trade-off
in terms of roses

860
00:38:47,950 --> 00:38:53,650
foregone to make a computer is
lower in the US than Colombia.

861
00:38:53,650 --> 00:38:59,830
And Colombia has a comparative
advantage in roses.

862
00:38:59,830 --> 00:39:02,200
The trade-off in terms
of foregone computers

863
00:39:02,200 --> 00:39:06,520
to make a rose is much lower
in Colombia than in the US.

864
00:39:06,520 --> 00:39:08,680
So comparative advantage
is about opportunity cost.

865
00:39:08,680 --> 00:39:09,830
Let me say it again--

866
00:39:09,830 --> 00:39:11,350
the US has a
comparative advantage

867
00:39:11,350 --> 00:39:14,080
in computers because
to make a computer,

868
00:39:14,080 --> 00:39:16,510
we have to give up less
roses than Colombia does.

869
00:39:16,510 --> 00:39:20,410
To make one computer, we
give up half a box of roses.

870
00:39:20,410 --> 00:39:22,417
That's the slope of this line.

871
00:39:22,417 --> 00:39:23,875
Colombia, to make
one computer, has

872
00:39:23,875 --> 00:39:26,790
to give up two boxes of roses.

873
00:39:26,790 --> 00:39:29,802
So we have a comparative
advantage in computers.

874
00:39:29,802 --> 00:39:30,649
Yeah.

875
00:39:30,649 --> 00:39:32,232
AUDIENCE: Would it
be possible to have

876
00:39:32,232 --> 00:39:34,128
comparative advantage in both?

877
00:39:34,128 --> 00:39:35,295
JONATHAN GRUBER: You cannot.

878
00:39:35,295 --> 00:39:36,510
That's the term "comparative."

879
00:39:36,510 --> 00:39:39,000
You can have an absolute-- in
this simple two by two model.

880
00:39:39,000 --> 00:39:39,610
You can have
comparative advantage

881
00:39:39,610 --> 00:39:40,800
in multiple things in life.

882
00:39:40,800 --> 00:39:42,690
From the simple model, you can
have the absolute advantage

883
00:39:42,690 --> 00:39:44,310
of both, but you can't have a
comparative advantage in both.

884
00:39:44,310 --> 00:39:45,390
That's absolutely right.

885
00:39:45,390 --> 00:39:47,563
In this model, with two
goods and two countries,

886
00:39:47,563 --> 00:39:49,230
each country has a
comparative advantage

887
00:39:49,230 --> 00:39:50,862
in one thing or the other.

888
00:39:50,862 --> 00:39:52,320
Or there could be
weird edge cases,

889
00:39:52,320 --> 00:39:54,870
but generally that's right.

890
00:39:54,870 --> 00:39:56,110
So now, I did computers.

891
00:39:56,110 --> 00:39:58,020
Now let's flip and do roses.

892
00:39:58,020 --> 00:40:01,260
In roses, for the US to
produce a box of roses,

893
00:40:01,260 --> 00:40:04,360
they have to give
up two computers.

894
00:40:04,360 --> 00:40:06,310
For Colombia to
produce a box of roses,

895
00:40:06,310 --> 00:40:08,140
they only give up
half a computer,

896
00:40:08,140 --> 00:40:10,360
so they have a comparative
advantage in roses.

897
00:40:13,140 --> 00:40:15,720
People understand the setup
here, these graphs on the left?

898
00:40:15,720 --> 00:40:16,812
Yeah.

899
00:40:16,812 --> 00:40:18,420
AUDIENCE: Does the
price of what you

900
00:40:18,420 --> 00:40:22,530
can sell each unit for factor
into what you actually produce?

901
00:40:22,530 --> 00:40:25,470
Because I can imagine
that yes, maybe you

902
00:40:25,470 --> 00:40:26,853
can produce more roses--

903
00:40:26,853 --> 00:40:28,520
JONATHAN GRUBER: But
they're worth less.

904
00:40:28,520 --> 00:40:29,820
AUDIENCE: --more
easily, but they-- you

905
00:40:29,820 --> 00:40:32,010
can't sell a rose as much
as you can [INAUDIBLE]

906
00:40:32,010 --> 00:40:32,220
JONATHAN GRUBER: Right.

907
00:40:32,220 --> 00:40:34,320
So for right now,
we're ignoring prices.

908
00:40:34,320 --> 00:40:36,000
We'll come back to prices
later, but for right now,

909
00:40:36,000 --> 00:40:37,083
we're ignoring the prices.

910
00:40:37,083 --> 00:40:38,700
Right now, we're just sort of--

911
00:40:38,700 --> 00:40:42,300
we're going to basically
have prices come in later,

912
00:40:42,300 --> 00:40:44,670
but for right now,
we're doing prices.

913
00:40:44,670 --> 00:40:48,300
So now, let's
imagine that tastes

914
00:40:48,300 --> 00:40:52,450
are such that
consumers in the US

915
00:40:52,450 --> 00:40:55,510
want 1,000 computers
and 500 boxes of roses.

916
00:40:55,510 --> 00:40:57,670
That's point C US.

917
00:40:57,670 --> 00:41:00,820
And consumers in Colombia
want 500 computers

918
00:41:00,820 --> 00:41:02,020
and 1,000 box of roses.

919
00:41:02,020 --> 00:41:03,250
I just made this up.

920
00:41:03,250 --> 00:41:06,265
C US and C CO, I
just made up tastes.

921
00:41:06,265 --> 00:41:08,890
I just said, let's just make it
a case where people in Colombia

922
00:41:08,890 --> 00:41:11,650
like roses better, people in
America like computers better.

923
00:41:11,650 --> 00:41:14,740
And imagine we do not
allow international trade.

924
00:41:14,740 --> 00:41:15,675
This is the best case.

925
00:41:15,675 --> 00:41:18,050
Actually, international trade
would be even more valuable

926
00:41:18,050 --> 00:41:19,217
with a different assumption.

927
00:41:19,217 --> 00:41:21,970
I've made assumptions which
make trade less valuable than it

928
00:41:21,970 --> 00:41:23,200
would otherwise be.

929
00:41:23,200 --> 00:41:25,660
I said look, Colombia produces
roses and people there

930
00:41:25,660 --> 00:41:26,990
like roses.

931
00:41:26,990 --> 00:41:29,650
American produce computers and
people there like computers,

932
00:41:29,650 --> 00:41:30,790
but not totally.

933
00:41:30,790 --> 00:41:32,260
Some US guy still
wants some roses.

934
00:41:32,260 --> 00:41:34,650
Some Colombian guy still
wants some computers.

935
00:41:34,650 --> 00:41:37,470
Now imagine we
don't allow trade.

936
00:41:37,470 --> 00:41:38,880
What's the outcome?

937
00:41:38,880 --> 00:41:42,900
Well, in the US,
we will produce--

938
00:41:42,900 --> 00:41:46,800
like I said, we want 1,000
computers and 500 roses,

939
00:41:46,800 --> 00:41:49,940
so we'll produce 1,000
computers and we'll

940
00:41:49,940 --> 00:41:52,130
consume 1,000 computers.

941
00:41:52,130 --> 00:41:53,630
So on the chart on
the right, you've

942
00:41:53,630 --> 00:41:55,550
got production and consumption.

943
00:41:55,550 --> 00:41:57,460
For the US, we'll
produce 1,000 computers,

944
00:41:57,460 --> 00:41:58,460
consume 1,000 computers.

945
00:41:58,460 --> 00:41:59,918
We have to consume
what we produce.

946
00:41:59,918 --> 00:42:01,500
There is no trade.

947
00:42:01,500 --> 00:42:03,720
And same with roses-- we'll
produce 500, consume 500.

948
00:42:03,720 --> 00:42:04,985
Colombia's the flip.

949
00:42:04,985 --> 00:42:08,580
So you end up in the world with
1,500 computers being produced

950
00:42:08,580 --> 00:42:11,343
and consumed, and 1,500 roses
being produced and consumed.

951
00:42:11,343 --> 00:42:14,010
Now, you might say that's silly,
computers cost more than roses.

952
00:42:14,010 --> 00:42:15,093
We'll come back to prices.

953
00:42:15,093 --> 00:42:19,100
For now, we're leaving
prices out of it.

954
00:42:19,100 --> 00:42:21,710
The point is, given
the tastes I've

955
00:42:21,710 --> 00:42:24,620
suggested with C US and C CO--

956
00:42:24,620 --> 00:42:26,320
I just made those up--

957
00:42:26,320 --> 00:42:29,120
given those tastes, we'll
end up in a situation where

958
00:42:29,120 --> 00:42:31,100
every country just
consumes what they produce,

959
00:42:31,100 --> 00:42:33,183
because there's no trade,
and the world as a whole

960
00:42:33,183 --> 00:42:39,080
will produce 1,500 boxes
of roses, 1,500 computers.

961
00:42:39,080 --> 00:42:44,620
Now let's say that
we allow trade.

962
00:42:44,620 --> 00:42:49,970
What trade does is introduce
economies of scope.

963
00:42:49,970 --> 00:42:50,920
Why?

964
00:42:50,920 --> 00:42:55,110
Because trade allows
specialization.

965
00:42:55,110 --> 00:42:57,890
Flip to the next figure.

966
00:42:57,890 --> 00:43:01,130
The next figure is the
figure for the world.

967
00:43:01,130 --> 00:43:05,590
Imagine the world
only wanted computers.

968
00:43:05,590 --> 00:43:08,005
That's the point on the y-axis.

969
00:43:08,005 --> 00:43:09,880
Then the US would produce
2,000, and Colombia

970
00:43:09,880 --> 00:43:10,713
would produce 1,000.

971
00:43:10,713 --> 00:43:12,650
We'd have 3,000.

972
00:43:12,650 --> 00:43:15,140
Imagine the world only
wanted roses, the flip side.

973
00:43:15,140 --> 00:43:17,300
We have 3,000.

974
00:43:17,300 --> 00:43:21,230
But if the world wants
both, you get more.

975
00:43:21,230 --> 00:43:22,130
Why?

976
00:43:22,130 --> 00:43:25,790
Why is it outward bending
when you allow trade?

977
00:43:25,790 --> 00:43:28,430
This is not a technological
change, change in technology.

978
00:43:28,430 --> 00:43:31,220
All we've done is
take these two PPS

979
00:43:31,220 --> 00:43:32,780
and combine them
and allow trade.

980
00:43:32,780 --> 00:43:34,947
Why does that suddenly
introduce economies of scope?

981
00:43:37,502 --> 00:43:38,960
Because what do
countries get to do

982
00:43:38,960 --> 00:43:40,310
compared to what they
were doing before when

983
00:43:40,310 --> 00:43:41,143
they couldn't trade?

984
00:43:41,143 --> 00:43:42,920
What do they get to do now?

985
00:43:42,920 --> 00:43:43,820
AUDIENCE: Specialize.

986
00:43:43,820 --> 00:43:47,120
JONATHAN GRUBER: Specialize
the US specializes in--

987
00:43:47,120 --> 00:43:49,790
and Colombia
specializes in roses.

988
00:43:49,790 --> 00:43:52,820
By specializing,
we can make more,

989
00:43:52,820 --> 00:43:55,140
because that's
what we're good at.

990
00:43:55,140 --> 00:43:59,700
So by trading, we
allow specialization.

991
00:43:59,700 --> 00:44:01,320
Without trading, we
can't specialize,

992
00:44:01,320 --> 00:44:02,570
because some guys in
the US want roses.

993
00:44:02,570 --> 00:44:03,510
We've got to make some roses.

994
00:44:03,510 --> 00:44:04,440
But that's stupid.

995
00:44:04,440 --> 00:44:05,750
We shouldn't make roses.

996
00:44:05,750 --> 00:44:08,130
We should let
Colombia make roses.

997
00:44:08,130 --> 00:44:10,500
If LeBron can't hire
anyone to mow his lawn,

998
00:44:10,500 --> 00:44:11,790
he's going to mow his lawn.

999
00:44:11,790 --> 00:44:13,050
That's stupid.

1000
00:44:13,050 --> 00:44:15,175
LeBron should hire someone
to mow his lawn and play

1001
00:44:15,175 --> 00:44:16,730
basketball all the time.

1002
00:44:16,730 --> 00:44:21,500
By allowing trade, we allow
people to specialize and take

1003
00:44:21,500 --> 00:44:24,680
advantage of their
comparative advantages.

1004
00:44:24,680 --> 00:44:26,878
Without trade, you
can't take advantage

1005
00:44:26,878 --> 00:44:27,920
of comparative advantage.

1006
00:44:27,920 --> 00:44:29,510
Without trade, it
doesn't matter if the US

1007
00:44:29,510 --> 00:44:31,260
is better at producing
computers or roses.

1008
00:44:31,260 --> 00:44:34,960
What's produced is just
determined by people's tastes.

1009
00:44:34,960 --> 00:44:38,110
But with trade,
you can specialize.

1010
00:44:38,110 --> 00:44:43,550
And that yields the outcome
we discussed in figure 18.5.

1011
00:44:43,550 --> 00:44:48,800
Figure 18.5 takes the previous
figure, 18.3, and adds trade.

1012
00:44:48,800 --> 00:44:50,030
So let me go through this.

1013
00:44:50,030 --> 00:44:51,800
The basic, the
blue, the PPFs are

1014
00:44:51,800 --> 00:44:55,080
the same on the left,
same PPFs as before.

1015
00:44:55,080 --> 00:44:59,720
And if you look at point CO
and C US [INAUDIBLE] before,

1016
00:44:59,720 --> 00:45:03,650
we could have 1,000 computers
and 500 roses in the US

1017
00:45:03,650 --> 00:45:06,800
or 1,000 roses and 500
computers in Colombia.

1018
00:45:06,800 --> 00:45:09,680
But now suppose we allow trade.

1019
00:45:09,680 --> 00:45:10,530
What happens now?

1020
00:45:10,530 --> 00:45:12,920
Well, what happens
now is the US goes

1021
00:45:12,920 --> 00:45:17,150
to producing only
computers and Colombia

1022
00:45:17,150 --> 00:45:21,700
goes to producing only roses.

1023
00:45:21,700 --> 00:45:24,080
Now let's assume, just
to make life easy,

1024
00:45:24,080 --> 00:45:26,467
let's just assume that people's
tastes are proportional.

1025
00:45:26,467 --> 00:45:28,300
So if there's more
computers and more roses,

1026
00:45:28,300 --> 00:45:30,133
they just want
proportionately more of each.

1027
00:45:30,133 --> 00:45:32,810
So the US, as
there's more of both,

1028
00:45:32,810 --> 00:45:35,980
wants two computers
for every rose.

1029
00:45:35,980 --> 00:45:37,990
And Colombia wants two
roses for every computer.

1030
00:45:37,990 --> 00:45:40,010
That's just their tastes.

1031
00:45:40,010 --> 00:45:43,700
What happens now is we shift
out to these new levels, C prime

1032
00:45:43,700 --> 00:45:47,320
US and C prime Colombia.

1033
00:45:47,320 --> 00:45:51,460
At the new levels, the US
produces 2,000 computers.

1034
00:45:51,460 --> 00:45:53,850
All they do is computers.

1035
00:45:53,850 --> 00:45:57,240
Colombia produces 2,000 roses.

1036
00:45:57,240 --> 00:46:01,270
The world as a whole
ends up with more.

1037
00:46:01,270 --> 00:46:04,150
Flip back two pages and look
at the table on the right.

1038
00:46:04,150 --> 00:46:06,430
The world as a whole
ended up with 1,500 roses

1039
00:46:06,430 --> 00:46:08,610
and 1,500 computers.

1040
00:46:08,610 --> 00:46:12,550
Now the world as a whole
ends up with 2,000 roses

1041
00:46:12,550 --> 00:46:15,720
and 2,000 computers.

1042
00:46:15,720 --> 00:46:16,800
What happened?

1043
00:46:16,800 --> 00:46:20,730
Nothing changed technologically,
same PPS here as before.

1044
00:46:20,730 --> 00:46:23,550
All the change is by trading.

1045
00:46:23,550 --> 00:46:26,580
We allowed people to exploit
their comparative advantage

1046
00:46:26,580 --> 00:46:28,440
through specialization.

1047
00:46:28,440 --> 00:46:32,130
Without trading, the US was
inefficiently producing roses

1048
00:46:32,130 --> 00:46:35,500
and Colombia was inefficiently
producing computers.

1049
00:46:35,500 --> 00:46:38,558
With trading, we've now
opened up the possibility

1050
00:46:38,558 --> 00:46:40,600
that they can specialize
in what they're good at.

1051
00:46:40,600 --> 00:46:42,433
And the world as a whole
ends up better off.

1052
00:46:45,230 --> 00:46:47,090
And look at both countries.

1053
00:46:47,090 --> 00:46:50,570
Both countries end up
with more consumption.

1054
00:46:53,210 --> 00:46:55,360
The US gets more computers,
so flip back and forth

1055
00:46:55,360 --> 00:46:57,030
between 18.3 and 18.5.

1056
00:46:57,030 --> 00:47:00,330
The US goes from 500
roses and 1,000 computers

1057
00:47:00,330 --> 00:47:03,450
to 750 roses and
1,250 computers.

1058
00:47:03,450 --> 00:47:08,940
Colombia goes from 1,000
roses and 500 computers

1059
00:47:08,940 --> 00:47:11,610
to 1,250 roses
and 750 computers.

1060
00:47:11,610 --> 00:47:13,380
Now, the split between
roses and computers

1061
00:47:13,380 --> 00:47:15,127
here is not determinate.

1062
00:47:15,127 --> 00:47:15,960
That's just made up.

1063
00:47:15,960 --> 00:47:17,710
I made up what tastes look like.

1064
00:47:17,710 --> 00:47:22,020
The point C and C prime,
that's just made up.

1065
00:47:22,020 --> 00:47:25,520
What you care about
is the bottom panel.

1066
00:47:25,520 --> 00:47:28,670
What you care about is fact
that the world as a whole

1067
00:47:28,670 --> 00:47:31,620
now has more roses and
more computers in it.

1068
00:47:31,620 --> 00:47:35,190
And that is the mechanics of
why international trade expands

1069
00:47:35,190 --> 00:47:38,140
our production
possibility frontier.

1070
00:47:38,140 --> 00:47:41,140
We have more goods
in the world once we

1071
00:47:41,140 --> 00:47:43,233
can trade, not because--

1072
00:47:43,233 --> 00:47:45,400
I mean, you still have the
same, where Pikachu and--

1073
00:47:45,400 --> 00:47:47,442
when I allow trade between
you and your friend,

1074
00:47:47,442 --> 00:47:48,900
that doesn't create
any more goods.

1075
00:47:48,900 --> 00:47:50,580
You each have two cards.

1076
00:47:50,580 --> 00:47:52,620
But in the real world,
it creates trade,

1077
00:47:52,620 --> 00:47:55,670
because the production
allows people to specialize.

1078
00:47:55,670 --> 00:47:57,280
And that's the beauty of trade.

1079
00:47:57,280 --> 00:48:00,750
We'll come back next time
and do a welfare analysis,

1080
00:48:00,750 --> 00:48:04,100
talking about why international
trade makes people better off.