Why

Nations
Trade
Chapter 18
1 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,
Penson, Capps, Rosson, and Woodward Upper Saddle River, NJ 07458. • All Rights Reserved.
 Discussion Topics
Why trade?
Absolute advantage
Gains from trade

2 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,

Penson, Capps, Rosson, and Woodward Upper Saddle River, NJ 07458. • All Rights Reserved.
 Concepts Affecting Trade
Absolute advantage – exists when one nation
can produce goods more cheaply than another
nation

Comparative advantage – ability of a nation to

specialize in the production of the good for
which it has lowest opportunity cost

Competitive advantage – economic

competitiveness of a nation reflected in the
absolute cost of a given good in a given market
3
at a particular point in time © 2010 Pearson Higher Education,
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward Pages 359-363
Upper Saddle River, NJ 07458. • All Rights Reserved.
 Comparative Advantage
Comparative advantage : If one nation is less
efficient in the production of a good than another
nation, there is still a basis of gains from trade
 A nation should specialize in production and export
the good for which its relative (comparative)
advantage is greatest
 A nation should specialize in production and export the good
for which it has the least relative disadvantage
 A nation should import the good for which its relative
(comparative) advantage is the least
 A nation should import the good for which it has the greatest
relative disadvantage
4 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,
Penson, Capps, Rosson, and Woodward Pages 359-363
Upper Saddle River, NJ 07458. • All Rights Reserved.
 Ratio

5.00
0.67

U.S. is most efficient producer of wheat while

Mexico is most efficient producer of coffee
With trade
 U.S.
 specializes in wheat
 exchange part of its surplus for coffee
 Mexico
 specialize in coffee
5 Introduction to Agricultural
 trade part of the surplus for wheatUpper Saddle River,©NJ201007458.
Economics, 5 ed
th Pearson Higher Education,
Penson, Capps, Rosson, and Woodward •Page 360
All Rights Reserved.
 Ratio

5.00
1.33

Mexico→ absolute disadvantage in producing both

goods
U.S.→ relative advantage greatest in wheat (10/2 vs.
4/3)
 → U.S. has a comparative advantage in wheat
 →Mexico has the least comparative disadvantage in coffee
or comparative advantage in coffee
6 Introduction to Agricultural Economics, 5 ed
th © 2010 Pearson Higher Education,
Penson, Capps, Rosson, and Woodward Upper Saddle River, NJ 07458. •Page 361
All Rights Reserved.
 Factors Affecting Comparative
Advantage….
National differences in opportunity costs
Costs affected by availability of resources
Costs affected by production
requirements for goods and services
produced
Costs affected by resource combinations
Costs affected by resource mobility

7 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,

Penson, Capps, Rosson, and Woodward Page 362
Upper Saddle River, NJ 07458. • All Rights Reserved.
  We assume both countries fully employ all
resources, technology and specific amounts of
labor per year
8 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,
Penson, Capps, Rosson, and Woodward Page 364
Upper Saddle River, NJ 07458. • All Rights Reserved.
 U.S./Mexico Production Possibilities

U.S
U.Sproduces
produces100
100tons
tonsof
of Mexico
Mexicoproduces
produces3232tons
tonsof
of
wheat
wheatand
and40
40tons
tonsof
ofcoffee.
coffee. wheat
wheatand
and12
12tons
tonsof
ofcoffee
coffee
200 40
U.S. (tons/year) Mexico (tons/year)
175
32
150
125 24
100
75 16
50
8
25
0 0
20 40 60 80 12 24 36 48 60

9 Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,

Penson, Capps, Rosson, and Woodward Page 365
Upper Saddle River, NJ 07458. • All Rights Reserved.
 U.S./Mexico Production Possibilities
B U.S. (tons/year)
200 40
Mexico (tons/year)
175 C 32
150

Wheat
Wheat

125 24
100
75
A 16
50
8
25
0 0
20 40 60 80 12 24 36 48 60
Coffee Coffee
Through trade
U.S. specializes in wheat (pt B)
Trades 50 tons of wheat to Mexico for 45 tons of coffee
Consumes more of both goods at pt C (45 tons of coffee and
150 tons of wheat) than at pt A.
Comparing C w/ A → U.S. better of with trade
Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,
10 Penson, Capps, Rosson, and Woodward Page 365
Upper Saddle River, NJ 07458. • All Rights Reserved.
 U.S. (tons/year) 50 C*
B Mexico (tons/year)
200 40
175 C A*
32
150

Wheat
Wheat

125 24
100
75
A 16
50
8
25
B*
0 0
20 40 60 80 12 24 36 48 60
Coffee Coffee
Through trade
 Mexico specializes in coffee, 60 tons, pt. B* and no wheat
 Would trade 45 tons of coffee for 50 tons of wheat
 Consume more of both goods (50 tons of wheat and 15 tons
of coffee, pt C*) than at pt A*
 Comparing C* w/ A* → Mexico better off with trade
Introduction to Agricultural Economics, 5th ed © 2010 Pearson Higher Education,
11 Penson, Capps, Rosson, and Woodward Upper Saddle River, NJ 07458. • All Rights Reserved.
 Summary
 The law of comparative advantage was contrasted with
absolute advantage and competitive advantage.
 Trade occurs because traders anticipate gains from
trading.
 Comparative advantage determines why nations trade.
 The basis for trade is differing opportunity costs among
nations.
 Nations specialize in producing those goods in which
they are most efficient and exchange these goods with
other nations.

12 Introduction to Agricultural Economics, 5 th

ed © 2010 Pearson Higher Education,
Penson, Capps, Rosson, and Woodward Upper Saddle River, NJ 07458. • All Rights Reserved.