Carbaugh, Chap. 2
12
Comparative advantage
Supply schedules: constant opportunity costs
Carbaugh, Chap. 2
13
Comparative advantage
Trading under constant opportunity costs
Generalizes theory to include all factors, not just labor Shows combinations of products that can be made if all factors are used efficiently Slope, or marginal rate of transformation, shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another)
Carbaugh, Chap. 2
5
Content
Historical development of modern trade theory Production possibilities schedules Trading under constant cost conditions Productivity and comparative advantage Trade restrictions Trade under increasing-cost conditions Comparative advantage extended to many products and countries
Comparative advantage: the US has an absolute advantage in both goods Output per labor hour Nation Wine Cloth United States United Kingdom
Carbaugh, Chap. 2
Carbaugh, Chap. 2
10
Comparative advantage
Marginal Rate of Transformation
Carbaugh, Chap. 2
11
Comparative abilities schedules: constant opportunity costs
After Specialization
Autos Wheat 120 0 120 0 160 160
Net Gain (Loss)
Autos Wheat 80 -40 40 -40 80 40
Carbaugh, Chap. 2
15
Comparative advantage
Consumption gains from trade: constant
Autos Wheat 7 -4 3 -4 7 3
Carbaugh, Chap. 2
24
Increasing opportunity costs
Consumption gains from trade:
increasing opportunity costs
Before Trade
Autos Wheat US Canada World 5 17 22 18 6 24 5 20 25
Carbaugh, Chap. 2
22
Increasing opportunity costs
Trading under increasing costs: Canada
Carbaugh, Chap. 2
23
Increasing opportunity costs
Production gains from specialization:
Key concepts and terms
Autarky Basis for trade Complete specialization Constant opportunity costs Consumption gains Exit barriers Free trade Gains from international trade
Carbaugh, Chap. 2
18
Comparative advantage
Trade restrictions and gains from trade
Carbaugh, Chap. 2
19
Increasing opportunity costs
Production possibilities schedule under increasing costs
40 bottles 40 yards 20 bottles 10 yards
8
Comparative advantage
Ricardo’s Comparative Advantage in money prices
Nation Labor Wage Cloth (yards) Quant. Price Wine (bottles) Quant. Price
Carbaugh, Chap. 2
6
Foundations of trade theory
Historical development of trade theory
Mercantilism
Regulation of trade to ensure a positive trade balance Critics: possible only for short term; assumes static world economy Absolute advantage (Adam Smith) Countries benefit from exporting what they make cheaper than anyone else But: nations without absolute advantage do not gain from trade
Carbaugh, Chap. 2
16
Comparative advantage
Complete specialization under constant opportunity costs
Carbaugh, Chap. 2
17
Comparative advantage
Changing comparative advantage
Comparative advantage (David Ricardo)
Nations can gain from specialization, even if they lack an absolute advantage
Carbaugh, Chap. 2
7
Comparative advantage
Carbaugh, Chap. 2
2
Increasing opportunity costs Labor theory of value Marginal rate of transformation Mercantilists Partial specialization Price-specie-flow doctrine Principle of absolute advantage Principle of comparative advantage
Carbaugh, Chap. 2
14
Comparative advantage
Production gains from specialization:
constant opportunity costs
Before Specialization
Autos Wheat US Canada World 40 40 80 40 80 120
Absolute & Comparative Advantage
Absolute advantage: each nation is more efficient in producing one good Output per labor hour Nation Wine Cloth
United States United Kingdom 5 bottles 20 yards 15 bottles 10 yards
opportunity costs
Before Trade
Autos Wheat US Canada World 40 40 80 40 80 120 60 60 120
After Trade
Autos Wheat 60 100 160
Net Gain (Loss)
Autos Wheat 20 20 40 20 20 40
4
Modern trade theory seeks to answer the following questions:
What constitutes the basis for trade? At what terms of trade are products exchanged in the world market? What are the gains from international trade in terms of production and comsuption?
increasing opportunity costs
Before Specialization