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International Economics
Tenth Edition
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
In this chapter:
Introduction
The Mercantilists Views on Trade Trade Based on Absolute Advantage: Adam
Smith Trade Based on Comparative Advantage: David Ricardo Comparative Advantage and Opportunity Costs The Basis for and the Gains from Trade under Constant Costs Empirical Tests of the Ricardian Model
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Introduction
Basic questions:
What is the basis for trade? What are gains from trade? What is the pattern of trade?
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Economic philosophy in 17th and 18th centuries, in England, Spain, France, Portugal and the Netherlands. Belief that nation could become rich and powerful only by exporting more than it imported.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Export surpluses brought inflow of gold and silver. Trade policy was to encourage exports and restrict imports. One nation gained only at the expense of another.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
stock of human, man-made and natural resources available for producing goods and services.
The greater the stock of resources, the greater the flow of goods and services to satisfy human wants, and the higher the standard of living.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
production of a commodity, but an absolute disadvantage with respect to the other nation in a second commodity, both nations can gain by specializing in their absolute advantage good and exchanging part of the output for the commodity of its absolute disadvantage.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
countries. Adam Smith and other classical economists advocated policy of laissez-faire, or minimal government interference with economic activity. Free trade would cause world resources to be utilized most efficiently, maximizing world welfare.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
U.K. has absolute advantage over U.S. in cloth. Both nations can gain from specialization in
production and trade.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
U.K. 1 5
U.S. 12 0
U.K. 0 10
U.S. 6 6
U.K. 5 5
U.S. 6-4=2
U.K. 5-1=4 -
the product that has Absolute Advantage US Specialize on Wheat then gain 2 additional Cloth UK Specialize on Cloth then gain 4 additional Wheat
Salvatore: International Economics, 10th Edition 2009 John Wiley & Sons, Inc.
Even if one nation is less efficient than (has absolute disadvantage with respect to) the other nation in production of both commodities, there is still a basis for mutually beneficial trade.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
U.K. 1 2
6 4
U.K.
UK has higher opportunity cost than US in Wheat production US has higher opportunity cost than UK in Cloth production
U.K. has absolute disadvantage in both goods. Since U.K. labor is half as productive in cloth but six times less productive in wheat compared to U.S., the U.K. has a comparative advantage in cloth. U.S. has comparative advantage in wheat.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
The value or price of a commodity depends exclusively on the amount of labor used to produce it.
The cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of the first commodity.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
FIGURE 2-1 The Production Possibility Frontiers of the United States and the United Kingdom.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
The Basis for and the Gains from Trade under Constant Costs
In the absence of trade, a nations production
specialization and trade represents nations gains from trade, allowing nations to consume outside production possibilities frontier.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
The Basis for and the Gains from Trade under Constant Costs
Under constant cost conditions, nations will
the equilibrium-relative commodity price of each commodity lies between the pretrade relative commodity price in each nation.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
FIGURE 2-4 Relative Labor Productivities and Comparative AdvantageUnited States and United Kingdom.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
2.8 2.6
Output per JPN Worker/ Output per KOR Worker
Precision Machinery.
1.0
2.0
3.0
4.0
5.0
6.0
FIGURE 2-4-K Relative Labor Productivities and Comparative AdvantageKorea and Japan.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.
FIGURE 2-5 Relative Exports and Relative Unit Costs United States and Japan.
Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.