Lecture B1 CH2 : Comparative Advantage

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Lecture B1 CH2 Comparative Advantage

• Dr. Michael A. Newsome
• ECN 420 International Trade
• Marshall University Students in Huntington
• Fall 2009 Regular Semester
• Wednesday, October 7, 2009

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History of Trade Theory Mercantilists
(1500-1800) A. Looked for a Favorable Trade
Balance Exports gt Imports.. Net Payment in
Gold and Silver.. Increased
Spending.. Increase Domestic
Output/Employment B. Proposed Tariffs and
Quotas to Minimize Imports C. Critiques i.
Hume Price Specie Flow Doctrine
Mercantilism Only Works in the Short
Run ii. Smith Specialization in Free Trade
can make the Whole World Richer
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History of Trade Theory 2. Absolute Advantage
(Adam Smith) A. Cost Differences Govern
International Trade Factor Input Productivities
are Important (Natural and Acquired
Advantages) Nation Produce Good for which it
has Lowest Cost B. Labor Thery of Value Cost
of a Good Depends on Labor to Produce It C.
Critique Ricardo Why do Countries Trade Even
When One Country has the Absolute Advantage in
Everything?
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History of Trade Theory 3. Comparative
Advantage (David Ricardo) A. Look at
Comparative Cost Differences Consider
Opportunity Costs. Relatively Efficient Country
should Produce the Good it is Best
At. Nation Produce Good for which it has Lowest
Cost B. Still Considered the Labor Theory of
Value to be True C. Critique What about
inputs other than Labor?
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Absolute Comparative Advantage
Absolute advantage each nation is more efficient
in producing one good Output per labor
hour Nation Wine Cloth United States 5 bottles 20
yards United Kingdom 15 bottles 10
yards Comparative advantage the US has an
absolute advantage in both goods Output per
labor hour Nation Wine Cloth United States 40
bottles 40 yards United Kingdom 20 bottles 10
yards
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Ricardos Comparative Advantage in money prices
Cloth (yards) Wine (bottles) Nation Labor Wage
Quant. Price Quant. Price US 1
hr 20/hr 40 0.50 40 0.50 UK 1
hr 5/hr 10 0.50 20 0.25 UK 1
hr 8 10 0.80 20 0.40 (at 1.6 1)
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Production Possibilities Schedules PPS (Constant
Costs) Moves Away from the Labor Theory of
Value Considers all Factor Inputs Land Labor
Capital Etc PPS Shows the Maximum Output
Possibilities of a Nation Marginal Rate of
Transformation MRT Shows The Amount of One
Good a Nation Must Sacrifice to Make One More
Unit of Another Good MRT Change in Q1
/ Chang in Q2
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Production Possibilities Schedules PPS (Constant
Costs) Constant Opportunity Costs Assume That
the Cost of Producing Any Good Does not
Increase as You Make More of It. 1. Factor of
Production are Perfect substitutes for Each
Other 2. All Units of a Factor Are of the Same
Quality Vocabulary of Trade 1. Autarky
Absence of Trade 2. Production Gains from
Trade How Much More Stuff the World Can Make
By Specializing and Trading 3. Consumption
Gains from Trade How Much More Stuff Each
Country and the World Can Consume By
Specializing and Trading
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Production Possibilities Schedules PPS (Constant
Costs) Vocabulary 4. Trading Possibilities
Line Line Showing Terms of Trade Between
Nations. Must Be In Between the PPS of the
Countries 5. Trade Triangle Shows Imports
and Exports of a Country in Trade Along a
PPS 6. Complete Specialization In Constant
Cost Conditions Countries will End Up Making
Only One Good Each! ltUnless One Country is
Tinygt
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Marginal Rate of Transformation
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Production possibilities schedules constant
opportunity costs
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Trading under constant opportunity costs
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Production gains from Specialization constant
opportunity costs
Before After Net Gain Specialization Specializat
ion (Loss)
Autos Wheat Autos Wheat Autos Wheat US 40 40 120
0 80 -40 Canada 40 80 0 160 -40 80 World 80 120 1
20 160 40 40
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Consumption gains from trade constant
opportunity costs
Comparative advantage
Before After Net Gain Trade Trade (Loss)
Autos Wheat Autos Wheat Autos Wheat US 40 40 60
60 20 20 Canada 40 80 60 100 20 20 World 80 120 12
0 160 40 40
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Production Possibilities Schedules PPS (Constant
Costs) So Where Do The Terms of Trade
Lie? -Production Costs Determine Outer Limits
of Terms of Trade -Costs Determine No-Trade
Boundary -Inside is the Region of Mutually
Beneficial Trade -Reciprocal Demand Determines
Where It Will Be Reciprocal
Demand Considers the Relative Strength of Each
Countrys Demand For the Other Countrys Good
The More A Country Demands the Other
Countrys Good, The Worse Its Terms of
Trade Small Countries Can Get Big Advantages
from Trade Importance of Being Unimportant
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Equilibrium terms-of-trade limits
Terms of Trade
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Production Possibilities Schedules PPS (Constant
Costs) Commodity Terms of Trade A Measure
of the International Exchange Ratio for a
Country, Considering All of Its Traded
Goods And Services Terms of Trade
Export Price Index X 100 Import Price
Index Improvement Requires Price of Exports
to Rise Relative to Price of Imports. Allows a
Country to Sell Less to Get the Same Stuff.
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Dynamic Gains from Trade Trade Can Increase a
Countrys Growth Over Time 1. Investment
Effect Increase Income.. More
Savings.. More Investment.. Higher
Productivity.. Higher Growth. 2.
Economies of Scale Effect Firms Get Bigger To
Satisfy Bigger Markets Average Costs of
Production Decrease. Evidence Shows that
Countries That Are Open to Trade Grow Faster.
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Dynamic Gains from Trade Trade Can Increase a
Countrys Growth Over Time 3. Competition
Effect Firms are Forced to Get Be More
Efficient Evidence Shows that Countries That
Are Open to Trade Grow Faster.
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Changing Opportunity Cost Over Time
Productivity Changes Can Effect Opportunity
Costs Within Nations Terms of Trade
Change Firms are Forced to Constantly Increase
Productivity!
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Changing comparative advantage
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Production Possibilities Schedules PPS
(Increasing Costs) Inputs are Imperfect
Substitutes for Each Other As you make more of
any product, it costs rise For Any
Product Increasing Costs Cause Diminishing
Marginal Productivity Diminishing Marginal
Productivities are Increasing Opportunity Costs
of Production. Causes The PPS to be CONCAVE
(Bowed Outward)
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Production possibilities schedule under
increasing costs
Increasing opportunity costs
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Production Possibilities Schedules PPS
(Increasing Costs) Countries with Increasing
Opportunity Costs of Production Specialize and
Trade Until The Relative Costs of Production
for Any Good Is the Same in Both Countries
Of course The Imports of Any Good from One
Country Must Equal The Exports of Goods
from the Other Country Under Increasing
Opportunity Costs of Production Partial
Specialization Will Occur
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Trading under increasing costs US
Increasing opportunity costs
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Trading under increasing costs Canada
Increasing opportunity costs
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Production gains from specialization increasing
opportunity costs
Increasing opportunity costs
Before After Net Gain Specialization Specializat
ion (Loss)
Autos Wheat Autos Wheat Autos Wheat US 5 18 12 1
4 7 -4 Canada 17 6 13 13 -4 7 World 22 24 25 27 3
3
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Consumption gains from trade increasing
opportunity costs
Increasing opportunity costs
Before After Net Gain Trade Trade (Loss)
Autos Wheat Autos Wheat Autos Wheat US 5 18 5 21
0 3 Canada 17 6 20 6 3 0 World 22 24 25 27 3 3
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• Comparative Advantage With Many Goods and
  Countries
• 1. Between Two Countries, Both Making Many
  Goods
• You can Rank the Goods by Degree of Comparative
  Costs
• -Some Goods will have Huge Differences in
  Comparative Costs
• -Some goods will have Small Differences in
  Comparative Costs
• Countries will Trade the Goods For Which they
  have the
• Greatest Comparative Advantage. Then move to
  the Next Good.
• Where is the Cutoff? Depends on Demand Factors
• More than Two Countries
• Multilateral Trading Relationships Occur.
• Means a Bilateral Balance Between Two
  Particular Countries
• Should Never be Expected.
• Bilateral Trade Agreement Reduce Overall
  World Trade

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Exit Barriers Normally under trade firms in
the Less Efficient Countries Close. But Exit
Barriers Exist Cost Conditions That Make it
Rational to Stay Open. Examples 1. High
Fixed Costs (Like Labor Contracts) 2.
Environmental And Regulatory Costs of
Closing 3. Political Costs of Closing
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Jobs and Outsourcing Empirical Evidence
Shows Very Small or No Relationship
Between Unemployment Rates and Imports as a
Percent of GDP --But the Type of Labor
Changes! Outsourcing Making Product
other Countries to Take Advantage of Lower
Costs (Usually Labor Costs) ---Causes much
Popular Resentment Recent Event Service Sector
Jobs Mover Overseas Because of Technology
(Internet, Communications)
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Jobs and Outsourcing Outsourcing
Allows 1. Consumer Prices to Decrease 2.
Overall National Wealth To Increase
However Some Sectors Lose. Example In US
Consumer Prices have Dropped Dramatically
but Low Skilled Labor Makes much Less than High
Skilled Labor Policy Recommendation Mainta
in Good Training Programs for Displaced
Workers Provide Temporary Unemployment Insurance
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Next WeekCH3 Sources of Comp Adv

• Dr. Michael A. Newsome
• ECN 420 International Trade
• Marshall University Students in Huntington
• Fall 2009 Regular Semester
• Wednesday, October 7, 2009