The Law of Comparative Advantage

Mercantilist thesis on trade (THUYẾT TRỌNG THƯƠNG)

The mercantilists maintained that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an inflow
of bullion, or precious metals, primarily gold and silver. The more gold and silver a nation
had, the richer and more powerful it was. Thus, the government had to do all in its power to
stimulate the nation’s exports and discourage and restrict imports (particularly the import of
luxury consumption goods). However, since all nations could not simultaneously have an
export surplus and the amount of gold and silver was fixed at any particular point in time, one
nation could gain only at the expense of other nations. The mercantilists thus preached
economic nationalism, believing as they did that national interests were basically in conflict.

Note that the mercantilists measured the wealth of a nation by the stock of precious metals it
possessed. In contrast, today we measure the wealth of a nation by its stock of human, man-
made, and natural resources available for producing goods and services. The greater this
stock of useful resources, the greater is the flow of goods and services to satisfy human wants,
and the higher the standard of living in the nation.

At a more sophisticated level of analysis, there were more rational reasons for the mer-
cantilists’ desire for the accumulation of precious metals. This can be understood if it is
remembered that the mercantilists were writing primarily for rulers and to enhance national
power. With more gold, rulers could maintain larger and better armies and consolidate their
power at home; improved armies and navies also made it possible for them to acquire more
colonies. In addition, more gold meant more money (i.e., more gold coins) in circulation and
greater business activity. Furthermore, by encouraging exports and restricting imports, the
government would stimulate national output and employment.

Mercantilism

Mercantilism is an economic theory that advocates government regulation of international

trade to generate wealth and strengthen national power.

Merchants and the government work together to reduce the trade deficit and create a
surplus.

Zero-sum
Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s
loss, so the net change in wealth or benefit is zero.

Absolute advantage (THUYẾT LỢI THẾ TUYỆT ĐỐI)

Invisible hand is a metaphor for how, in a free market economy, self-interested individuals
operate through a system of mutual interdependence to promote the general benefit of
society at large.

Absolute advantage
Absolute advantage is the ability of an individual, company, region or country to produce a
good or service at a lower cost per unit than another entity that produces the same good or
service.
 An entity with an absolute advantage can produce a product or service using a smaller
number of inputs or a more efficient process than another entity producing the same good or
service.

Comparative advantage
Comparative advantage is an economy's ability to produce a particular good or service at a
lower opportunity cost than its trading partners. A comparative advantage gives a company
the ability to sell goods and services at a lower price than its competitors and realize
stronger sales margins.

The law of comparative advantage

David Ricardo:
Comparative advantage is an economic term that refers to an economy's ability to produce
goods and services at a lower opportunity cost than that of trade partners.
A comparative advantage gives a country the ability to sell goods and services at a lower
price than its competitors.
1. Only two countries, two commodities;
2. Free trade;
3. Perfect mobility of labor within each nation but immobility between two nations
4. Cost of production is constant;
5. No tranortation cost;
6. No change in technical status;

LIMITATIONS OF THESIS
1. The doctrine has not shown the competitive model in a monopoly and imperfect competition
2. The impact of the government on trade
3. Comparative doctrine in static economy
4. The doctrine simply revolves around TG with 2 countries

COMPARATIVE ADVANTAGE AND OPPORTUNITY COST

Opportunity costs represent the potential benefits an individual, investor, or business misses
out on when choosing one alternative over another.
IDEAS:
1936 – Theory of International Trade (1936)
Gottfried Haberler: Austrian-American economist:
Reinvented
Ricardian theories and the formation of alternative opportunity cost theory for label value
theory
Ø The value of gross output on the market is determined by the total number of labor required
for production.
-Natural value is the original value to produce the product
-"Political" value = Market value is difficult to predict due to market changes.

Ø The opportunity cost of an alternative is defined as the cost of not choosing the "next
best" alternative.

The production possibility frontier under constant cost.

 PPF is a curve that shows the alternative combinations of the two commodities that a Nation
can produce by fully utilizing all of its resources with the best technology available to it.

Opportunity cost
Opportunity cost is the quantity of goods to be sacrificed to produce the remaining goods.

HECHKSCHER – OHLIN THEORY

Heckscher-Ohlin theory, in economics, a theory of comparative advantage in international
trade according to which countries in which capital is relatively plentiful and labour
relatively scarce will tend to export capital-intensive products and import labour-intensive
products, while countries in which labour is relatively plentiful and capital relatively scarce
will tend to export labour-intensive products and import capital-intensive products.

Some meanings from the theory.

• Labor intensive refers to a process or industry that requires a large amount of labor to
produce its goods or services.
• Capital intensive refers to business processes or industries that require large amounts of
investment to produce a good or service.
• A country is labor abundant if its endowment of labor is large compared to other countries.
• A country is capital abundant if its endowment of capital is large compared to other
countries

Porter Diamond
Michael Porter’s Diamond Model (also known as the Theory of National Competitive
Advantage of Industries) is a diamond-shaped framework that focuses on explaining why
certain industries within a particular nation are competitive internationally, whereas others
might not. And why is it that certain companies in certain countries are capable of consistent
innovation, whereas others might not? Porter argues that any company’s ability to compete
in the international arena is based mainly on an interrelated set of location advantages that
certain industries in different nations posses, namely: Firm Strategy, Structure and Rivalry;
Factor Conditions; Demand Conditions; and Related and Supporting Industries. If these
conditions are favorable, it forces domestic companies to continuously innovate and
upgrade. The competitiveness that will result from this, is helpful and even necessary when
going internationally and battling the world’s largest competitors.

CHAPTER 4 – KTQT
TRADE RESTRICTION
 Increase the Government Budget: Collecting income from the tax/ tariff
 Protect our domestic products/ domestic firms (enterprise): protect the local market
segmentation
 Create more chance and enhance the exportation
 Protect the habitant avoid buying bad/ products
Market policy:
 New market expansion policy
 Policy to strengthen and develop the old market
 The policy of economic and trade linking the region, globally, facilitates growth
Supporting policies :
 Foreign investment policy
 Price policy
 Exchange rate policy
TYPES OF TRADE POLICY
 Free trade is a policy by which a government does not discriminate against imports
or interfere with exports by applying tariffs (to imports) or subsidies (to exports).
1.Free trade eliminates the distortion of consumption, production, damage from trade barriers
2.Stimulate competition Quality and efficiency increase
3.Contribute to improving your level, skills and technology
4.Helps to use resources more efficiently
5.Condemns the intervention leading to market imbalance by the Government
 Globalization is the spread of products, technology, information, and jobs across
national borders and cultures. In economic terms, it describes an interdependence of
nations around the globe fostered through free trade.
PROTECTION POLICY

Reason why a country wants to apply protectionism policy

1.Free trade will lead to unemployment in some industries; making it difficult for new
industries. The labor market is not fair;
2.Protecting new industries is also stressful
3.The elimination of import tax will cause large losses
4.Domestic labor protection. Protecting domestic companies
5.Against the case of dumping in the domestic market6.Prevent luxury; Unsuitable and cause
social imbalance
Fair trade policy
To implement measures against:
1.Dumping products
2.Import Tax
3.Production subsidies
General issues on taxes
Tax calculation method :
1. Taxes calculated on the basis of quantity: Taxes calculated per unit of material and
commercial goods. (Absolute Tax)
2. Value-added tax: Taxes calculated as a percentage of the value of commercial goods.
3. Mixed taxes: Combined taxes between the two.
A tariff is a customs duty levied on imported and exported goods and services.
The purpose of the import tax:
1. The young industry.
2. Taxation is also a discriminatory tool among national partners.
3. Taxes increase revenue for CP.
4. Creation of domestic products to increase competitiveness for imported products.