| << Chapter < Page | Chapter >> Page > |
A second issue raised by the parable: What can go wrong? Robinson’s proposal to Friday introduces an element of uncertainty. Friday is, in effect, making a loan of fish and coconuts to Robinson, and Friday’s happiness with this arrangement will depend on whether that loan is repaid as planned, in full and on time. Perhaps Robinson spends several months loafing and never builds the irrigation system. Or perhaps Robinson has been too optimistic about how much he will be able to grow with the new irrigation system, which turns out not to be very productive. Perhaps, after building the irrigation system, Robinson decides that he does not want to repay Friday as much as previously agreed. Any of these developments will prompt a new round of negotiations between Friday and Robinson. Friday’s attitude toward these renegotiations is likely to be shaped by why the repayment failed. If Robinson worked very hard and the irrigation system just did not increase production as intended, Friday may have some sympathy. If Robinson loafed or if he just refuses to pay, Friday may become irritated.
A third issue raised by the parable of Robinson and Friday is that an intimate relationship exists between a trade deficit and international borrowing, and between a trade surplus and international lending. The size of Friday’s trade surplus is exactly how much he is lending to Robinson. The size of Robinson’s trade deficit is exactly how much he is borrowing from Friday. Indeed, to economists, a trade surplus literally means the same thing as an outflow of financial capital, and a trade deficit literally means the same thing as an inflow of financial capital. This last insight is worth exploring in greater detail, which we will do in the following section.
The story of Robinson and Friday also provides a good opportunity to consider the law of comparative advantage , which you learn more about in the International Trade chapter. The following Work It Out feature steps you through calculating comparative advantage for the wheat and cloth traded between the United States and Great Britain in the 1800s.
In the 1800s, the United States and Britain traded wheat and cloth. [link] shows the varying hours of labor per unit of output.
| Wheat (in bushels) | Cloth (in yards) | Relative labor cost of wheat (Pw/Pc) | Relative labor cost of cloth (Pc/Pw) | |
|---|---|---|---|---|
| United States | 8 | 9 | 8/9 | 9/8 |
| Britain | 4 | 3 | 4/3 | 3/4 |
Step 1. Observe from [link] that, in the United States, it takes eight hours to supply a bushel of wheat and nine hours to supply a yard of cloth. In contrast, it takes four hours to supply a bushel of wheat and three hours to supply a yard of cloth in Britain.
Step 2. Recognize the difference between absolute advantage and comparative advantage. Britain has an absolute advantage (lowest cost) in each good, since it takes a lower amount of labor to make each good in Britain. Britain also has a comparative advantage in the production of cloth (lower opportunity cost in cloth (3/4 versus 9/8)). The United States has a comparative advantage in wheat production (lower opportunity cost of 8/9 versus 4/3).
Step 3. Determine the relative price of one good in terms of the other good. The price of wheat, in this example, is the amount of cloth you have to give up. To find this price, convert the hours per unit of wheat and cloth into units per hour. To do so, observe that in the United States it takes eight hours to make a bushel of wheat, so 1/8 of a bushel of wheat can be made in an hour. It takes nine hours to make a yard of cloth in the United States, so 1/9 of a yard of cloth can be made in an hour. If you divide the amount of cloth (1/9 of a yard) by the amount of wheat you give up (1/8 of a bushel) in an hour, you find the price (8/9) of one good (wheat) in terms of the other (cloth).
Notification Switch
Would you like to follow the 'Principles of economics' conversation and receive update notifications?
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|