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Conclusions From Comparative Advantage Theory
Conclusions From Comparative Advantage Theory
• Both countries gain from increasing the price of exports relative to price
of imports.
• Countries, with free trade specialise in products they export.
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Some observed trade patterns between
developing (India)
and
developed (USA and Germany)
nations:
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India- USA major trade items
Exports to USA Imports from USA
Pearls, precious stones, metals, coins Machinery, nuclear reactors, boilers #
Pharmaceutical products* Pearls, precious stones, metals, coins
Other made textile articles, sets, worn Electrical, electronic equipment #
clothing etc* Optical, photo, technical, medical, etc
Mineral fuels, oils, distillation products, etc apparatus #
Machinery, mechanical appliances, nuclear Aircraft, spacecraft, and parts thereof #
reactors, boilers; parts thereof Mineral fuels, oils, distillation products
Articles of apparel, accessories, not knit or
crochet*
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India - Germany major trade items
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China – US trade
Skill composition of US- China Trade (1990)
Skill group (industry examples) % of China’s % of US export
export to US to China
Most skilled
Periodicals, office and computing machines 4.8 7.7
Aircraft and parts, industrial organic chemicals 2.6 48.8
Engines and turbines , fats and oils 3.9 21.3
Concrete, non electronic plumbing, and heating 11.5 4.3
Watches, clocks, toys, sports goods 18.9 6.3
Wood buildings blast furnaces, basis steel 8.2 1.3
Ship building and repair, furniture, fixtures 4.1 2.8
Cigarettes, motor vehicles, iron and steel foundries 5.2 1.8
Weaving, wool, leather tanning and finishing 17.2 0.4
Children’s outerwear, non rubber footwear 23.5 5.2
Least skilled
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Socks made in USA, clothes from Mexico
• USA imports almost 2/3 of its apparel consumption despite complex trade
restrictions.
• Most of the import comes from Mexico, China, Caribbean nations, India.
• Mexico, being a part of NAFTA, faces less restrictions and is the largest
exporter.
• Production is low skill labour intensive
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Identifying that cost advantage could be due to factor
Factor Proportions abundance.
Other assumptions
• Perfect competition in product and factor market
• Identical consumption pattern in trading countries
• Uniform production technology across counties
• Wages and rents may be different across borders
Due to
• Decreasing returns to factors (increasing opportunity
Eli Heckscher
costs), but constant returns to scale
and
Bertil Ohlin
Factor abundance – comparing countries
K/L
• X is a relatively labour intensive product than Y
L req. for unit production of X / K req. for unit production of X
> L req. for unit production of Y / K req. for unit production of Y
Or Lx/Kx > Ly/Ky
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• Consider that both countries have identical demand combination for products.
(one of the assumptions)
Demand for x in A/ Demand for y in A = Demand for x in B/Demand for y in B
Qxa/Qya = Qxb/Qyb = z say
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L supply in A/K supply in A > L supply in B/K supply in B
Can we predict
where would the relative prices be higher
under autarky?
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Trade pattern is decided on the basis of relative prices.
Px/Py in A or Px/Py in B – which is higher?
If and only if
wa.Lx + ra.Kx /wa.Ly + ra.Ky > or = or < wb.Lx + rb.Kx /wb.Ly + rb.Ky
• This is the very condition for comparative advantage. And predictions on the basis
of Comparaive advantage theory holds good. 12
Country A: Px/Py in A < Px/Py in B Country B:
• Labour abundant nation • Capital abundant nation
Country A: Country B:
• Hence the rise in workers wages, • Hence the rise in rental for capital,
fall in rental for capital fall in workers wages
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Technology based comparative advantage
vis-à-vis
resource based comparative advantage
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Reading
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