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Class # 3
(see Chapter 2 of Ken Heads book)

Gains from Trade

Comparative advantage within firms
and between countries
Rodrigo Wagner

Adapted from KennethHeads slides for his book Fund.ofmultinational Management

Brands included donot meanrealexamples but only used for teaching purposes.

Assignment ingroups (30min)

Optimizing

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Productivity Matrix
Clean a toilet
Cleanatoilet

NeighborA

4units /hour

Mowgrassin
Mow
grass in
onestandard
garden
3units /hour

NeighborB

1units /hour

2units /hour

Yourassignment:
Objectivefunction: Maximizecorporateshoe
output.
Controlvariables:numberofworkersineachoftwo
factories(Korea&Thailand)toallocatetoeachof
twoactivities(moldingsoles&stitchinguppers).
Constraints:
Number ofworkers is given,cant fire people,Cant move
people
l to another
h country
450 workers inThailand
300 workers inKorean Factory.

One UPPERandone SOLEperoshoe !

Assumptions:Transport costs arenegligible

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Afewshoeterms
Upper

Sole

ProductivityMatrix

Activity:

Factory:

Uppers

Soles

Korea

15

45

Thailand

10

20

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Computetotalshoeoutputin3scenarios
PlanA:(selfsufficientfactories):
Eachcountrycombinesworkerstoproduce
completed shoes There is no trade insolesor
completedshoes.Thereisnotrade
in soles or
uppers.

PlanB: Thailandspecializes
Thailandproducesonlyuppers,
Koreaproducessolesanduppers.

PlanC:KoreaSpecializes
Koreaproducesonlyuppers,
Thailandproducessolesanduppers.

PlanA(selfsufficientfactories):
LetscallLu,Lsthenumberofworkersin
uppersandsellers;andQthequantities.
Thailand:Qu=Qs
Thailand: Qu=Qs 10Lu=20(300Lu)
10 Lu = 20 (300Lu)
Lu=300,Ls=150,output=3000shoes
Korea:U=S 15Lu=45(300Lu)
Lu=225Ls
Lu
225 Ls =75,output
75, output =3375shoes
3375 shoes
Combinedoutput =6375shoes
CorporateProductivity6375/750=8.5shoesperworker

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PlanB:Thailandspecializesinuppers
Thailand:Lu=450 4500uppers
Korea:Qu=Qs 4500+15Lu=45(300Lu)
Lu=150 2250U,Ls=150 6750S
Combinedoutput:6750shoes

4500shoesstitchedinThailandusingsolesimportedfrom
g
p
Korea
PLUS2250finishedshoesmadeinKorea.

Productivity:9shoesperworker

PlanC:KoreaspecializesinUppers
Korea:Lu=300 4500uppers
Thailand:U=S 4500+10Lu=20(450Lu)
Lu=150 1500U,Ls=300 6000S
Combinedoutput:6000shoes

4500shoesstitchedinKoreausingsolesimportedfrom
Thailand
PLUS1500 finishedshoesmadeinThailand

Productivity:6000/750=8shoes/worker

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PlanBincreasesshoeoutputby6%
Firmlevelproductivityrises8.5to9shoesperday
Outputgrowth:(67506375)/6375=.06
Nonewmachinery,nonewskills,noextraeffort.
Tradeislikeanewtechnology!

Specializationisnotenough
PlanC,involvesspecializationbutitlowers output
by 6% relative to Plan A
by6%relativetoPlanA.
Specializationbasedoncomparativeadvantage
yieldsgainsfromtrade.
Comparativeadvantage=lowopportunity
C
ti
d t
l
t it costs.
t
Comparativeadvantagegains=matching process

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Opportunitycostcalculations
Opportunitycostofuppersinforegonesoles
Thailand:20S/10U=2S/U
Korea:45S/15U=3S/U

Opportunitycostofsolesinforegoneuppers
Thailand:10U/20S=0.5U/S
Korea:15U/45S=0.33U/S
/
/

Koreahasloweropportunitycostofsoles.

Rulesofthumb vs
Numeric Optimization
Lookatthe opportunity cost ofone good interms
of foregone production ofthe
offoregone
of the other good!
UseExcels SOLVERtool asshown inclass:
Defineobjective function (production)
Goal:Maximize
Definerestrictions:nonnegativity;balanceatthe
plant level or atthe firm level.
Spreadsheet exercise available online

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Concluding remarks
Comparative advantage is auseful
managementt technique
t h i
t improve
to
i
productivity !
Think about the opportunity cost ofresources.
Differentiate absolute from comparative
advantage.