U.K.
1 2
- The U.S. is more efficient than (or has an absolute advantage over) the U.K. in the production of both commodities. - The U.K. is less efficient than (or has an absolute disadvantage over) the U.S. in the production of both commodities.
slide 2
2.2 The Mercantilists’ Views on Trade
The more gold and silver and a nation had, the richer and more powerful it was. Thus the way for a nation to become rich is to export more than it imported. The resulting export surplus would then be settled by an inflow of bullion or precious metals such as gold and silver. Thus the mercantilists advocated restrictions on imports and incentives for exports.
slide 4
2.3 Trade Based on Absolute Advantage: Adam Smith
Adam Smith, The Wealth of Nations, 1776. 2.3A. Absolute Advantage When one nation is more efficient than (or has an absolute advantage over) another in the production of one commodity but is less efficient than (or has an absolute disadvantage with respect to) the other nation in producing a second commodity,
slide 11
2.4 Trade Based on Comparative Advantage: David Ricardo
2.4B. The Gains from Trade
- The relative prices of Wheat before trade: U.S.: (Pw/Pc)us = 4/6 = 2/3 U.K.: (Pw/Pc)uk = 2/1 = 2 - If the U.S. exchanges 6W for 6C, the U.S. gains 2C or saves 1/2 hour of labor time. Similarly the U.K. also gains. - The U.S. would be indifferent to trade if it received 4C from the U.K. in exchange for 6W. The U.S. wouldn’t trade if it received less than 4C for 6W.s Nhomakorabeaide 10
2.4 Trade Based on Comparative Advantage: David Ricardo
- But the U.K. has a comparative advantage in cloth, and the U.S. has a comparative advantage in wheat. Explain! (6:1, 4:2) - With trade, the U.S. would specialize in the production of wheat and exchange part of it for British cloth. - The opposite is true for the U.K. - If the U.S. exchanges 6W for 6C, the U.S. gains 2C or saves 1/2 hour of labor time. Similarly the U.K. also gains. Explain! (domestic 6W↔6C)
If one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, the first nation should specialize in the production of and export the commodity in which its absolute disadvantage is small (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage).
slide 1
2.1 Introduction
Two Basic questions of international trade theory.
(1) What is the basis for trade and what are the gains from trade? How – generate, large, divided (2) What is the pattern of trade? – commodity
slide 7
2.3 Trade Based on Absolute Advantage: Adam Smith
The U.S. is more efficient than (or has an absolute advantage over) the U.K. in the production of Wheat but is less efficient than (or has an absolute disadvantage with respect to) the U.K. in producing Cloth. With trade, the U.S. would specialize in the production of wheat and exchange part of it for British cloth. The opposite is true for the U.K. If the U.S. exchanges 6W for 6C, the U.S. gains 2C or saves 1/2 hour of labor time. Similarly the U.K. also gains. Note: Absolute advantage can explain only a very small part of world trade.
slide 3
2.2 The Mercantilists’ Views on Trade
A nation can gain in international trade only at the expense of other nations. i.e., “Trade is a zero-sum game.” WHY? Criticism: (1) The measure of the wealth of a nation? (2) Rulers vs. common people Case Study 2-2 Mercantilism is Alive and Well in the Twenty-First Century
slide 6
2.3 Trade Based on Absolute Advantage: Adam Smith
2.3B. Illustration
Table 2.1. The number of units produced by each hour of labor time
U.S.
Wheat(bushels/hour) Cloth(yards/hour) 6 (36) 4 (24)
International Trade Theory
Chapter 2: The Law of Comparative Advantage
OUTLINE
2.1 Introduction 2.2 The Mercantilists’ Views on Trade 2.3 Trade Based on Absolute Advantage: Adam Smith 2.4 Trade Based on Comparative Advantage: David Ricardo 2.5 Comparative Advantage and Opportunity Costs 2.6 The Basis for the Gains from Trade Under Constant Costs 2.7 Empirical Tests of the Ricardian Model
slide 5
2.3 Trade Based on Absolute Advantage: Adam Smith
then both nations can gain by each specializing in the production of the commodity of its absolute advantage and exchanging part of its output with the other nation for the commodity of its absolute disadvantage.