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Part I
2.0 Introduction
International Trade Theory

Chap.2 the Law of Comparative Advantage • 2.0a Main issues in trade theory
Chap.3 Neoclassical Trade Theory
Chap.4 Modern Trade Theory • 2.0b Framework of international trade
Chap.5 Economic Growth and International theory
Trade

2.0 Introduction 2.0a Main issues in Trade Theory

Why do people trade?
2.0a Main issues in Trade Theory =What is the basis for trade?
• gains from trade : when countries sell goods and
• Why do people trade? services to one another, this is almost always to their
mutual benefit
• What is the pattern of trade?
• how are gains from trade generated?
• Effects of trade
how large are the gains?
• Trade in goods and factor movement how are they divided among the trading
nations
David Ricardo’s Model
Heckscher-Olin Model
Economies-of-scale Model

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2.0a Main issues in Trade Theory 2.0a Main issues in Trade Theory

What is the pattern of trade? Effects of trade
• David Ricardo :international differences ---- effects on the distribution of income :
in labor productivity
owners of resources
• Heckscher-Olin Model : supplies of
national resources between broad groups----
workers and the owners of capital
• Others: economies of scale and
imperfect competition

2.0a Main issues in Trade Theory 2.0 Introduction

2.0b Framework of International
Trade in goods and factor Movement
Trade Theory
• tangible goods :
a trade of labor for goods and services from 17 th century, the Mercantilists ’
view on trade before Classical trade
• international migration and theory, till Modern Trade Theory as
international borrowing : Vernon’s theory based on Product cycle
a trade of current goods for the
promise of future goods

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3 Trade based on comparative advantage: David Ricardo • 2.5 the basis for and the gains from trade under • 2.4 Comparative advantage and opportunity cost international trade • 2. 2018-6-29 2.0b Framework of International Trade Theory Chap.2 Trade based on absolute advantage: Adam Smith before Adam Smith • 2.0b Framework of International Trade Theory 2.1 The mercantilists’ view on trade • 2.1b The main ideas of Mercantilism on • 2.1 The Mercantilists’ View on Trade • 2.2 The law of comparative advantage 2.6 Empirical tests of the Ricardian Model alive today 3 .1c Trade Policies advocated by Mercantilists constant costs • 2.1a Economic thought in international trade • 2.1d Mercantilism: Older than Smith but still • 2.

or may abate their vent by the use of century). economic nationalism.1 The mercantilists’ view on trade 2. For…that on international trade that advocated an economic part of our stock [exports] which is not returned to us in ware philosophy known as mercantilism.1 The mercantilists’ view on trade 2 . France. discourage and restrict and only from foreign trade. stimulating the nation ’s exports. was to export more than it imported. • During the fifteenth and eighteenth centuries a group means therefore to encrease our wealth and treasure is by of men (merchants.1b The main ideas of Mercantilism on international trade 2. rather than to lose the utterance [the sale] of such wares …   • Source: Thomas Munn. and may also have the same form other Nations. •   •   • 2. to protect the nation ’s industry precious metals. • The words in brackets have been added to clarify the meaning. that was gold silver)was the and commerce and promote the development of main form if not the only form of wealth foreign trade. Therefore mercantilists maintained that the wherein we must ever observe this rule. we must in this case strive to sell as cheap as possible we can. but also we must consider out neighbours necessities.1b The main ideas of Mercantilism on Adam Smith international trade • Writings on international trade preceded Adam Smith Thomas Munn (1571-1641) in such countries as England. Oxford: Basil Blackwell. The main source of wealth was from trade. But the superfluity of our commodities which strangers use. wherein we must ever observe this rule. England’s Treasure by Foreign Trade ( Reprinted.1b The main ideas of Mercantilism on international trade the main idea of mercantilism: 3. or by purchase taken from some other Nations. equal. Foreign Trade. encrease our wealth and treasure is by Foreign Trade. and also endeavourer to sell them dear. England’s Treasure by Foreign Trade and the Netherlands as they developed into modern l         Case Study 2-1 Munn ’s Mercantilistic View on Trade Although a kingdom may be enriched by gifts received. government officials. to sell more to way for a nation to become rich and powerful strangers yearly than we consume of their in value. protectionism 2. 4. national states. to sell more and even philosophers) wrote essays and pamphlets to strangers yearly than we consume of theirs in value. Import (particularly luxury goods) compulsive means 4 . Portugal. In order to get money from trade a country The mercantilists took money and wealth as should keep balance of trade. [imports] must necessarily be brought home in treasure • Two stages: [bullion]… the earlier stage of mercantilism (from We may … diminish our importations. Money (at that time measured by the stock of economy actively. to keep foreign trade with export surplus . if we would soberly refrain from excessive the end of 15 th century to the mid of 16 th century) consumption of foreign wares in our diet and raiment [dress] …In our exportations we must not only regard our superfluities. so far forth as the second part of 16 th century to the end of 17 th the high price cause not a less vent in the quantity [of our exports]. bankers. Spain.1aEconomic thought in international trade before 2. believing that the increasing of nation ’s That is. wealth was the same as the increasing of Thomas Munn : The ordinary means therefore to nation’s money. The government should interfere national 1. 1928). and with little inconvenience. that so … we the later stage of mercantilism (from may… gain so much of the manufacture as we can. some such like wares from other places. The ordinary yet these are things uncertain and of small consideration when they happen. 2018-6-29 2.

but not production. and “Squeezing the Textile Workers. restricting imports of ordinary manufactures by imposing high tariffs.From restricting trade to promoting trade mercantilists in the earlier stage : constraint money 4.000 at the turn of the century. is still alive and well in the twentieth century. the United States had bilateral textile the “bubble economy ” in Japan export restraints arrangements with 46 countries and the industry was • Mercantilists advocated strict government control of getting more protection than any other major U..3 million all economic activity and preached economic in 1980 to less than 800. Thus. most of them continue to impose many restrictions on international trade . 311 — 335. This was searched the source of wealth in circulation (for them followed in 1974 by the Multifiber Arrangemnet (MFA). the role of government. most restrictions on textile exports remain. • resurgence of neo-mercantilism • In fact. p. Still. subsidy and 2.1c Trade Policies advocated by Mercantilists 2. reactions to the mercantilists ’ views on trade and on Source: D. “Trade Protection and Welfare in the United States. the fable of IT disappearing and clothing imports into the United States and other industrial countries and extended it to also cover synthetic fibers.S. (gold and silver) inside the country Supporting the development of infant industries from fierce mercantilists in the later stage : put money into the competition of foreign industries by the means of tariffs . is to lower those tariffs by 25 percent by 2005. As in most cases. ” The New York Times. Savlatore. The government directly interfered foreign trade by controlling the channels of trading . under pressure from imports and automation. nationalism because they believed that a nation could The multilateral trade agreement. measurements of exempting from duty.1c Trade Policies advocated by Mercantilists 1. ed. though declining. 2018-6-29 2. and Trade increased money. known as the Uruguay Round.a classic mercantilist request . which took effect in 1995 will replace quantitative restrictions on textile imports by equivalent tariffs (taxes) on imports and gain in trade only at the expense of other nations .1d Mercantilism: Older than Smith but still l         Case Study 2-2 Mercantilism is Alive and Well in the Twentieth Century alive today Although most nations claim to be in favor of free trade. growth of all textile and clothing imports into the United States by 6 percent per year. By 1995. trade restrictions are demanded to protect trade : a zero-sum game win-win game domestic jobs from foreign competition---. February 21. which limited the was foreign trade). no Western nation has ever been completely free of mercantilist idea. Some of the big trading corporations were authorized monopoly power by the government. Savatore. in 1956 the United States and • The fatal weakness of the mercantilism was that they other industrial nations began to restrict exports of cotton textiles from Japan . 3. Subsequent renewals and extensions of the MFA further limited textile Asian crisis in 1997. Protectionism and World Welfare (New York: Cambridge University Press.  Promoting foreign trade by strengthening system materials treated by low tariffs or free of duty. pp. while imports of raw  5. These restrictions were then extended to developing countries in 1962 . profitable foreign trade Enhancing the competition of domestic industries by the Thomas Munn : Money generated trade. • The ideas of classical economists are regarded as Mercantilism. ordinary merchants----sectors supporting trade. 5 . and organization Export: exports of commodities given special treatment as exempting from Trading system : nation----monopoly corporations---- duty or offering subsidies. industry . Awarding export while restricting import Privileged rights Import: strongly opposing imports of luxury goods. Government interfering The government had monopoly power on foreign trade. ” in D. aside from England during the period 1815-1914. D1. For example. 1993).1d Mercantilism: Older than Smith but still alive today 2. 2. Supporting foreign trade by domestic industries. 1996. employment in the industry declined from 1.

published in 1776 2. 2018-6-29 The Father of Economics: Adam Smith (1723-1790) 2.countries trade because they are different • Masterwork: Inquiry into the Nature and Causes of the Wealth of the from each other Nations (abbr.2 Trade Based on Absolute Advantage: • invisible hand:operation of market forces Adam Smith • markets would guide economic activity and act like an invisible hand allocating resources. Advantage: Adam Smith • Scotland            One of the founders of Classical Economics Countries engage in international trade for two • The first economist setting up the theory of international division of basic reasons gain from trade labor and international trade 1.1723 .2 Trade Based on Absolute • Adam Smith was born on June 5 th. • Prices would be the main means to do this. countries trade to achieve economies of scale •          Symbol of Political Economics in production being an independent subject •      Investigating the origin of wealth In the real world. best outcome for all concerned 6 .: Wealth of Nation ).                     I n t h i s b o o k . advocated the idea of laissez faire (on international trade that is free trade ) The Father of Economics: Adam Smith (1723-1790) 2. patterns of international trade and the conditions for its increasing reflect the interaction of both these motives. • the 'invisible hand' would organize markets and ensure that they arrived at the optimum outcome • self-interest . A d a m S m i t h attacked mercantilists’ views of protective trade policy.

g. but free to move within the country Productivity or Cost of Production • Full employment. the number of hours commodity Production of labor required to produce a unit of product (aLW and aLC) • Absolute advantage: When one country If country A requires 1 unit of labor in can produce a unit of a good with less producing one pound of cheese. Wheat (Q W) and Cloth (Q C) • Basis for trade: Absolute Advantage in • One input: Labor (L) Commodity Production • Different technologies: different productivity of • Determination of the Absolute Advantage: labor differences in technology • Labor supply is fixed. and U.2a Model of Absolute Advantage by 2. that is a *LC advantage over the second one in =1. 2018-6-29 2. Advantage • Two outputs: e. No international labor • Measurements of Absolute Advantage: movement. perfect competition. exchange country B.2a Model of Absolute Advantage by 2.5. U. • get benefit from trade 7 .5 units of labor in that the first country has an absolute producing one pound of cheese. producing that good.2a Model of Absolute Advantage by Adam Smith Adam Smith technology labor productivity Basis for trade: Absolute Advantage in • unit labor requirement.g. we say =1. If country B requires 1. that is aLC resource than the other country. and constant • Pattern of production and trade return to scale • Gains from trade • No transportation cost • Trade Policy • Balanced trade 2.S.2a Model of Absolute Advantage by Adam Smith Adam Smith Basic Assumptions for the Model of Absolute Advantage • Basic Assumptions for the Model of Absolute • Two Countries: e. aLC < a*LC means the technology in producing • purchasing cost was less than the cheese in country A is more advanced than in production cost.K.

the nation with cost of production of commodity was that the nation had more aL has an absolute advantage over the nation advanced technology of producing this commodity. the example of pin-making. with a*L or had absolute advantage.2a Model of Absolute Advantage by Adam Smith Determination of the Absolute Advantage: Measurements of Absolute Advantage: differences in technology Productivity or Cost of Production If a nation had higher productivity on a commodity • higher productivity =absolute advantage than another nation. • differences in technology caused by labor “professional” productivity and occupational division of labor .2a Model of Absolute Advantage by Adam Smith 2. focusing on one kind of job would stimulate innovation. 2. aL=L/Q • The reason for the second nation to export a If aL < a*L. 2. product line. then we could say it had lower productivity =absolute disadvantage absolute advantage on this commodity over the second one. 3.the labor would be more skillful by specialization.2a Model of Absolute Advantage by Adam Smith Adam Smith Determination of the Absolute Advantage: differences in technology • reasons for the effect of division of labor on Determination of the Absolute Advantage: increasing productivity differences in technology 1. 2018-6-29 2. division of labor could save the time of transferring from one kind of work to another. • cost of production:the unit of labor • The reason for a nation to import a commodity requirement in each unit of output was that the nation had a disadvantage on the technology of producing this commodity. such as inventing new machines and new techniques that would shorten working time and be laborsaving. lower per-unit cost 8 .2a Model of Absolute Advantage by 2.

25 1. then both nations can gain by each specializing in the production of the commodity of its absolute China 1.00 advantage and exchange part of its output with the other nation for the commodity of its absolute disadvantage.5 U.00 2. specializes in and exports wheat.2a Model of Absolute Advantage by Adam Smith Measurements of Absolute Advantage: Measurements of Absolute Advantage: Productivity or Cost of Production Productivity or Cost of Production Table 2-1 Possible Output (L =L *=100) Table 2-2 Productivity (P=Q/L)   Rice (ton) Wheat (ton)   Rice  Wheat  China 100 50 China 1. U.00 • U.0 0.S. 1. 2018-6-29 2. 0.S. • China specializes in and exports rice.2a Model of Absolute Advantage by Adam Smith 2. 9 .0 2. 80 100 U.S.2a Model of Absolute Advantage by 2.S.8 1.2a Model of Absolute Advantage by Adam Smith Adam Smith Measurements of Absolute Advantage: Productivity or Cost of Production Pattern of production and trade: when one nation is more efficient than (or has an absolute advantage over) another in the production Table 2-3 Production Cost (a L=L/Q ) of one commodity but is less efficient than (or has an absolute disadvantage with respect to) the other   Rice  Wheat  nation in producing a second commodity.

• Absolute advantage : (P=Q/L a L=L/Q) (Pu. or has an absolute advantage over.k) w=1 Wheat (bushels/man-hour)                         6                       1 The U. (a u. 2018-6-29 2.s) c=4 < (Pu. (au.s) c=1/4 > (au. the output of both commodities will rise.K. or has an absolute Cloth (yards/man-hour)      4                       5 advantage over.K.s) w=6 > (Pu. • Production condition (Pu.S.2a Model of Absolute Advantage by 2. 10 . the United Kingdom on the production of wheat. • a policy of laissez-faire: • This increase in the output of both as little government interference with the commodities measures the gains from economic system as possible specialization in production available to be divided between the two nations through trade.                 U. Table 2-4  Absolute Advantage   2.S.k) w= 1.k) c=5 .                 U. Wheat (bushels/man-hour)                          6                       1 Table 2-4  Absolute Advantage Cloth (yards/man-hour)      4                       5      U. from free trade and strongly advocated a total output and the welfare of all nations are policy of laissez-faire maximized.s) w=1/6 < (au. the United States on the production of cloth.S is more efficient than.k) c=1/5 The United Kingdom is more efficient than.2a Model of Absolute Advantage by Adam Smith Adam Smith Gains from trade: Trade Policy: • resources are utilized in the most efficient • Smith believed that all nations would gain way.2b Illustration of Absolute Advantage    U.

the United Kingdom gains 24C or save The United Kingdom would specialize in the almost 5 man-hours. • Table 2-5 Possible Output (L =L *=100) • What is important is that both nations   Rice (ton) Wheat (ton) can gain from specialization in China 100 50 production and trade. just needs 6C ) 2. production of cloth and exchange part of it for (The 6W that the United Kingdom receives from the United American wheat. the United States would specialize If 6W=6C.                 U.   11 .K. Wheat (bushels/man-hour)                          6                       1 Wheat (bushels/man-hour)                         6                       1 Cloth (yards/man-hour)      4                       5 Cloth (yards/man-hour)      4                       5 • Pattern of trade: • Gains from trade : With trade. by trading.S. the U.2c Limitation of the Smith Model • Table 2-1 Possible Output (L =L *=100) Attention   Rice (ton) Wheat (ton) • The fact that the United Kingdom gains China 100 50 much more (24C) than the United U.k.    U. 80 100 States (2C) is not important at this time. (Domestically the United States can only exchange 6W for 4C) for British Cloth.2b Illustration of Absolute Advantage 2. the United States gains 2C or saves in the production of wheat and exchange part of it 1/2 man-hour.S.K. 2018-6-29 Table 2-4  Absolute Advantage   Table 2-4  Absolute Advantage      U. has an absolute advantage on both of  the two commodities. U. 150 100 The U.S.                 U.S. States would require six man-hours of labor time to produce in the United Kingdom.S. Six man-hours can produce 30C in the United Kingdom .

• Full employment. the law of comparative advantage • Absolute advantage will be seen to be only a special case of the more general theory of comparative advantage. One of the Greatest Economists: 2.g. but free to move within the country Economics and International Trade Theory. U.3a Model of Comparative Advantage by David Ricardo (1772-1823) David Ricardo David Ricardo was born Basic Assumptions for the Model of Comparative in1772.g. his masterwork: return to scale Principles of Political economy • No transportation cost and Taxation was published. been a financier wallowing in • Two outputs: e.K. No international labor development of Classical movement. perfect competition. could not be explained by absolute advantage David Ricardo. • Balanced trade 12 . however. 2018-6-29 2. • One input: Labor (L)   At the age of 27. 2. Wheat (Q W) and Cloth (Q C) money. he had • Two Countries: e. Ricardo devoted to researching • Different technologies: different productivity of economic issues labor    Contributing a lot to the • Labor supply is fixed.3 Trade Based on Comparative • Most of world trade.S. such as some of the trade between developed and developing countries . London: Advantage At the age of 25. especially trade among Advantage: David Ricardo developed countries.2c Limitation of the Smith Model • Absolute advantage. can explain only a very small part of world trade today. and U. and constant     In 1817.

Table 2-6 Comparative Advantage even if one nation is less efficient than (has an    U.K. absolute disadvantage with respect to) the other nation in the production of both commodities. and China 1.S.                 U. 2018-6-29 2. 2. we say that it has a   Rice  Wheat  comparative advantage in X.0 6. Cloth (yards/man-hour)      4                       5 13 . Wheat (bushels/man-hour)                          6                       1 there is still a basis for mutually beneficial trade.3a Model of Comparative Advantage by 2.S. U.0 comparative disadvantage in Y.S. has a comparative advantage in wheat.3a Model of Comparative Advantage by 2. 2. greater (this is the commodity of its comparative Wheat (bushels/man-hour)                          6                       1 disadvantage).S.0 1. and a comparative disadvantage in rice. and a comparative disadvantage in wheat. But if the degree of advantage is greater in X. Cloth (yards/man-hour)      4                       2 • The nation should specialize in the production of and export the commodity in which its absolute Table 2-4 Absolute Advantage disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is    U.3a Model of Comparative Advantage by David Ricardo David Ricardo • Possible Output (L =L *=100) Comparative advantage:   Rice (ton) Wheat (ton) refers to the degree of advantage.                 U. 200 600 advantage over country B in commodities X Productivity (P=Q/L) and Y.0 The U.S.3b Illustration of Comparative David Ricardo Advantage According to the law of comparative advantage.K. China has a comparative advantage in rice. China 100 100 Country A can have an absolute U.

3c Exception to the Law of Advantage Comparative Advantage Table 2-7 Exception to the Law of • Gains from trade: Comparative Advantage If 6W=6C.3b Illustration of Comparative 2. man-hours. the United Kingdom gains 6C or saves almost 3    U.3b Illustration of Comparative 2. 14 . The United States specializes in the The degree of American Advantage over the production of wheat and exports some of it in exchange for British cloth. 2.3b Illustration of Comparative Advantage Advantage • Production Condition • Comparative advantage: The United States has absolute advantage over the • Pattern of trade: United Kingdom in the production of both goods. The United Kingdom specializes in the In the model of two countries.                 U. the production of cloth and exports some of it in analysis can be expressed by asserting that the United exchange for American wheat.S. Wheat (bushels/man-hour)                          6                       3 Cloth (yards/man-hour)      4                       2 Both nations can gain from specialization in production and trade. United Kingdom is not the same in both industries. States has a comparative advantage in wheat while the United Kingdom has a comparative advantage in cloth. two outputs. the United States gains 2C or saves 1/2 man-hour.K. 2018-6-29 2.

but free to move within the country • 5)        Full employment.4a Comparative Advantage and the 2. no technical change • 4)        Labor supply is fixed. 2018-6-29 2. and still a basis for mutually beneficial trade. with respect to the other nation) is in the same proportion for the two commodities.3c Exception to the Law of 2.4 Comparative Advantage and Labor theory of Value Opportunity Cost Basic assumptions of the Ricardian Model: • 1)        Two Countries • 2)        Two outputs 2. there is advantage in neither commodity. Even if one nation has an absolute • The United Kingdom (and the United disadvantage with respect to the other nation in States) would then have a comparative the production of both commodities. unless no mutually beneficial trade could take the absolute disadvantage (that one nation has place. and • constant returns to scale • 6)        No transportation cost • 7)        Balanced trade • 8)        One input: Labor (L) 15 .3c Exception to the Law of Comparative Advantage Comparative Advantage • The degree of American Advantage • Modifying the statement of the law of over the United Kingdom is the same in comparative advantage : both industries. perfect competition.4a Comparative Advantage and the • 3)        Different technologies: different productivity of Labor theory of Value • labor. 2. No international labor • movement.

there is a have been used to produce other goods. where it is summer in February rather than greenhouse. South American workers are less efficient than their investment. But is South America. share of the market for winter roses in the United States is Those 10 million Valentine ’s Day roses could instead have been grown in being supplied by imports flown in from South America. Then the the occasion to make a speech denouncing the growing imports of flowers opportunity cost of those 10 million roses is 100. for example. it is a lot easier to grow February roses in rose s in F e bruary.S. the growers out of business.4b The Opportunity Cost Theory Opportunity Cost (CONT ’D) Case Study 2-3 Rose and Computer---- Suppose.  Labor is homogeneous (only one type). Those resources could U. 16 .000 into the United States. It seems extremely likely that the opportunity cost of that a bad thing? those roses in terms of computers would be less than it would be in the Consider first how hard it is to supply American sweethearts with fresh United States. So the trade-off in South America might be something economy must produce less of other things. Republican presidential candidate Patrick Buchanan stopped at a nursery to buy a dozen roses for his wife. capital winter. He took those roses could have produced 100. computers. and that the resources used to grow On Valentine ’s Day. and other scarce resource. Inevitably. at great expense in terms of energy. 2. For one thing.4a Comparative Advantage and the Labor theory of Value • Ricardian School: 19 century “conquered the whole England” • The main theorem in the labor theory of value is. In order to produce winter roses. Conversely.000 computers. the U. The flowers must be grown in heated the Southern Hemisphere.S.000 computers instead.000 computers would be 10 mullion roses. such as like 10 million winter roses for only 30. 2018-6-29 2. Labor is the only factor of production. which he claimed were putting American flower computers. that the United States currently grows 10 million Opportunity Cost roses for sale on Valentine ’s Day.4b The Opportunity Cost the value or price of a commodity depends Theory exclusively on the amount of labor going into the production of the commodity: 1. counterparts at making sophisticated goods such as computers. • The theory of comparative advantage needs not be based on the labor theory of value but can be explained on the basis of the opportunity cost theory Case Study 2-3 Rose and Computer---- 2. Stated.   2. if the computers were produced instead. which means that a given amount of resources used in computer production yields fewer computers in South American than in the United trade-off. 1996. Furthermore. And it is indeed true that a growing opportunity cost of those 100.

should specialize in producing wheat and • The U. is 1. of 1 yard of cloth in The U. and a comparative disadvantage in the second The resource cost. Comparative Advantage • According to comparative advantage based on the Wheat (bushels/man-hour)                          6                       1 opportunity cost theory.                 U.K. 2018-6-29 Case Study 2-3 Rose and Computer---- Opportunity Cost (CONT ’D) 2.5 bushels of wheat.4b The Opportunity Cost Theory Table 2-9 Opportunity Cost and Comparative Advantage The opportunity Cost theory and    U. meanwhile.4b The Opportunity Cost Theory 2. must be given up to release just enough resources to produce one Table 2-8 Hypothetical Changes in Production additional unit of the first commodity.S.K. the cost of 1 bushel of • Cloth is cheaper (in terms of wheat) in the U. Let • Opportunity Cost: the United States stop growing winter roses and devote the resources this frees up to producing computers. 1 yard of cloth in the U.S.10 + 100 South America + 10 .K: 1W=2C export some of it in exchange for British cloth. Wheat is cheaper (in terms of textiles) in the U.4b The Opportunity Cost Theory This difference in opportunity costs offers the possibility of a mutually beneficial rearrangement of world production. shifting the necessary resources out of its the amount of a second commodity that computer industry. • The U. the cost of 1 export some of it in exchange for American wheat. should specialize in producing cloth and the U.S. or the opportunity cost. let South America The opportunity cost of a commodity is grow those roses instead.30 Total 0 + 70 2.S.6W= 4C. must give up 6 bushels of wheat to obtain 4 has a comparative advantage in that commodity. Conversely.K. is 0.S.K. the nation with the lower Cloth (yards/man-hour)      4                       2 opportunity cost in the production of a commodity • The U. Million Roses Thousand Computers United States . The the opportunity cost. bushel of wheat is 2 yards of cloth. of commodity. wheat is 2/3 yard of cloth. The resulting changes in production would look like Table 2-8. yard of cloth.5 bushels of wheat. 17 .

and the U. Figure 2-3 The Production Possibility The Characteristics of PPF Frontiers of the U.S.K. The opportunity cost of one unit of wheat in the U.4c The Production Possibility and Cloth in the U.K. and the U.4 Production Possibility Frontier 18 . The opportunity cost of one unit of wheat in the U. is 1W=2/3C and remain constant. Frontier under Constant Costs United States United Kingdom Wheat Cloth Wheat Cloth 180 0 60 0 The Production Possibility Frontier is a 150 20 50 20 curve that shows the alternative 120 40 40 40 combination of the two commodities 90 60 30 60 that a nation can produce by fully 60 80 20 80 30 100 10 100 utilizing all of its resources with the best 0 120 0 120 technology available to it. Figure2. 2018-6-29 Table 2-10 Production Possibility Schedules for Wheat 2.S.K. is 1W=2C and remains constant.S.

4d Opportunity Costs and Relative Commodity Prices PPF with Decreasing Cost • Relative price: is the price of one good in terms of the other. 2018-6-29 PPF with Increasing Cost PPF with Constant Cost 2. (P w /Pc ). • Basis for Trade Lower relative price----export Higher relative price----import 19 .

• If Pw /Pc= aw/ac.5< (Pc /Pw) u. 20 . the economy will the relative price of cloth is less than its specialize in the production of cloth. both goods will be produced. the economy will specialize in the cloth exceeds its opportunity cost. = 2 = (P w /Pc) u.5 The U.4d Opportunity Costs and Relative 2.k = 0.k=2 The U.5 (Pc /Pw) u. (aw/ac) u.5 advantage and provides the basis for mutually beneficial trade. opportunity cost. 2018-6-29 2.s • (Pc /Pw) u. has comparative advantage in wheat. (P c /Pw< ac/aw ).k difference in the slope of their opportunity cost) is a reflection of their comparative (Pc /Pw) u.4d Opportunity Costs and Relative 2. • The difference in relative commodity prices • United Kingdom: between the two nations (given by the (aw/ac) u.s = 1. income in it will specialize in the production of wheat if the cloth sector will be higher.k.4d Opportunity Costs and Relative Commodity Prices Commodity Prices The relationship between relative price and Relationship between prices and production: opportunity cost: The economy will specialize in the • If Pw /Pc> aw/ac.s=2/3 < (Pw /Pc) u. 2.k = 0. income in the wheat and cloth sector will be the same. (P c /Pw> ac/aw ).S. that is P c /Pw> ac/aw.s. = 2/3 = (P w /Pc) u. income in the wheat sector will production of cloth if the relative price of be higher .4d Opportunity Costs and Relative Commodity Prices Commodity Prices • United States : • (Pw /Pc) u. production of wheat.K has comparative advantage in cloth. • If Pw /Pc<aw/ac.s = 1.

5b Relative Commodity Prices with Trade Figure 2-7 Equilibrium-Relative Commodity Prices with 2. 21 . 2.5a The Gains from Trade • The United States gains 20W and 10C from trade (from CIC u.k to CIC u. • The United Kingdom gains 30W and 10C from trade (from CIC u.s to CIC u.5a The Gains from Trade Demand and Supply Wheat Cloth • Where do gains come from? The increased consumption of both wheat and cloth in both nations was made possible by the increase output that resulted as each nation specialized in the production of the commodity of its comparative advantage.k’).s’). • The output of wheat increases from 130W to 180W.6 The Gains from Trade 2. the output of cloth increases from 100C to 120C.5 The Basis for and the Gains from Trade Under Constant Costs Figure 2. 2018-6-29 2.

2018-6-29 Table 2-9 Opportunity Cost and Comparative Advantage Figure 2-8 Region of Mutually Beneficial Trade    U.K. studies over the years.6 Empirical Tests of the Ricardian Model Empirical Tests 1 • The pioneering study was conducted by MacDougall in 1951 and 1952. 22 .S. using labor The basic prediction of the Ricardian productivity and export data for 25 industries in the model----that countries should tend to U. for the year 1937.5 bushels of wheat for the United States 1 yard of cloth = minimum of 0. Wheat (bushels/man-hour)                          6                       1 Cloth (yards/man-hour)      4                       2 maximum of 1.K. and the U.5 bushel of wheat for the United Kingdom 2.6 Empirical Tests of the Ricardian Model 2.K.                 U. export those good in which their • The positive relationship between labor productivity productivity is relatively high----has been and exports for the United States and the U. • Additional and more recent confirmation of the Ricadian trade model is provided by Golub in a 1995 study.S. was confirmed by subsequent studies by Balassa using strongly confirmed by a number of 1950 data and Stern using 1950 and 1959.

In part.09 man-days.S. Hourly Output per Unit Labor and the increase in imports----of autos and steel. 23 . However.02 down from 4.9 0.64 any workers per day to assemble a vehicle. Japan Germ.95 1.S exports---.18 High Technology/All Manufactures 0.07 1. 2018-6-29 Empirical Test 2 Case Study 2-4 Examples from U. and Mfg. of steel and the “wrong” product mix and inferior quality Steel Steel in the case of automobiles. To do that.88 in 1989. requires only 2. Iron and Steel/All Manufactures 1. This is U.93 1. Japan’s most efficient automaker.42 1.S. France 754 632 221 233 341 271 Table 2-12 Ratio of Unit Labor Cost Within Three Countries. Motor Vehicles/All Manufactures 1. much of the U.S. • General Motors (GM). Trade Table 2-11 Indices of Unit Labor Cost in Iron and Steel and All In the 1970s and the early 1980s. 1980-1981 Since the 1980s Industry Ratio U. 382 316 119 141 321 224 deterioration can be analyzed in terms of production costs.K. it is necessary to rank all industries Japan 725 807 352 394 206 205 within each country by order of their production cost: Germany 448 461 227 217 197 212 from the lowest to the highest cost industries. 827 898 119 167 689 538 equivalent to ranking them by comparative advantage.S. Trade(CONT ’D) Case Study 2-4 Examples from U. requires 3.57 0.08 • Nissan. Compensation Hour Cost this was widely attributed to wrong managerial decisions: delays in the introduction of new technology in the case Country Iron and All Iron All Iron All Steel Mfg. much public Manufacturing For 1980(1964= 100) in Five Countries attention was focused on the decline in U. and Mfg.