Import and Export Management

Muhammad Zahid Malik

zahid.malik@iqra.edu.pk
Absolute vs. Comparative Advantage
 Absolute vs. Comparative
Advantage
• Absolute Advantage:
– Either: A) an individual/firm/country can can produce more
of a good with the same input as another country
– B) Can produce a certain output using a fewer amount of
resources as another (mainly illustrated in terms of time)
• LEBRON HAS ABSOLUTE ADVANTAGE IN MOWING HIS LAWN!
• Comparative Advantage:
– Whoever can produce a good with a lower opportunity
cost!!!
– More influential in production than absolute advantage!
• FELIX HAS COMPARATIVE ADVANTAGE IN MOWING LEBRON”S
LAWN!
 Result of Specialization
• Production of “Widgets” demonstration
• Why don’t we all make our own houses,
grow/gather our own food, heal our own
wounds?
– Trade
• Increases our standard of living…we assume
• Specialization—the division of tasks which
leads to gains from trade (me and you, or
entire world economy)
 Adam Smith Says:
• In 1776s The Wealth of Nations Smith
describes what you just witnessed
– 18th century pin factory, where rather than 10
workers making a pin from start to finish, each
worker should specialize in one of the tasks in
completing one pin…
– “those 10 persons, therefore, could make among
them upwards of forty-eight thousand pins in a
day. But, if they had all wrought separately and
independently…they certainly could not each of
them have made twenty.”
 Why Comparative Advantage is Key

• Suppose that an American worker can produce 50

shirts or 200 bushels of wheat per day. A Chinese
worker can produce only 25 shirts or 50 bushels of
wheat.
– The U.S. has an absolute advantage in shirt production
since a U.S. worker can produce more shirts than a
Chinese worker.
– The U.S. has an absolute advantage in wheat production
since a U.S. worker can produce more wheat than a
Chinese worker.
Why Comparative Advantage is Key
• To understand how each country decides
which good to produce when they interact, we
calculate opportunity cost:
– U.S.: 1 shirt costs 4 bushels of wheat—1 wheat
costs ¼ shirt
– China: 1 shirt costs 2 bushels of wheat –1 wheat
costs ½ shirt

• Therefore, China should specialize in shirts

and the U.S. in wheat.
 Absolute and Comparative
Advantage Illustrated

• Which is which?
– Country B—Absolute
in both
– Country A—
Comparative in car
production
 Input Model

• Told about what resources are needed to produce one unit of

a good in order to calculate opportunity cost.
– “…required to produce…”
– “…per hour…”
• Input model--- number goes “under”
 Output Model

• Given final data on the amount of a good that can be produced

with a given amount of input to calculate opportunity cost.
• Output model---number goes “over”
 Gains From Trade
Suppose the U.S. has 150 million workers and China 800 million.
Without trade, each nation produces and consumes on their own based on their
preferences.
Let us assume the U.S. produces 5 billion shirts and 10 billion wheat.
Let us assume China produces 10 billion shirts and 20 billion wheat.
Alone, they are inefficient because…
When specialized, producing the good they have a comparative
advantage
in total production increases. See below…
Gains From Trade
 Terms of Trade
• We can use all the information we can now
calculate to determine a fair “price” for
different producers to seek when trading. Use
their opportunity costs.
• Keep in mind: There is room for trade as long
as the two countries differ in their opportunity
costs to produce a good and they set a
“trading price” that falls between those
opportunity costs.
 Terms of Trade
• After specialization, assume the two countries agree to trade 20 billion
bushels of wheat for 7.5 billion T-shirts. Are the outcomes going to be an
improvement for both countries?
– In our example from yesterday,
• U.S.: 1 shirt costs 4 bushels of wheat—1 wheat costs ¼ shirt
• China: 1 shirt costs 2 bushels of wheat –1 wheat costs ½ shirt

So,
• the price at which China and the U.S are willing to trade T-shirts must fall
between China’s opportunity cost for producing T-shirts and U.S.’s
opportunity cost for producing T-shirts.
• China is the country that specializes in T-shirts, and it cannot charge a price
greater than the U.S.’s opportunity cost.
• Conversely, China must receive a price that covers its opportunity costs for
making T-shirts, or it will not be willing to trade.
 Terms of Trade
• From our original example: US producing 200 wheat and 50 shirts,
while China produces 50 wheat and 25 shirts…
– US opportunity costs: 1 wheat costs ¼ shirt—1 shirt costs 4 wheat
– China opportunity cost: 1 wheat costs ½ shirt—1 shirt costs 2 wheat;
therefore,
• USA (wheat): before trade, the opportunity cost of making a T-shirt in
the U.S was 4 bushels of wheat. Thus USA has no incentive to trade
unless USA can get 1 T-shirt from China for less than 4 bushels of
their wheat production
• CHINA (T-shirts): before trade, China’s opportunity cost of making 1
T-shirt was 2 bushels of wheat. Thus China will not be willing to trade
their T-shirts for U.S.’s wheat unless they can receive more than 2
bushels of wheat in exchange for 1 of their T-shirts.
• Thus the mutually beneficial terms of trade for 1 T-shirt (1T) is:
• Terms of Trade for T-shirts: “ 2W < 1T < 4W ”
 Remember…
• NO country has comparative advantage in
everything and every country has comparative
advantage in something…
– This fact deems trade essential for “efficient”
production
– What is this interaction called?
– What are its implications on the world and it’s
people?