international trade theory the law of comparative advantage mc 2009
DESCRIPTION
slide Introduction Two Basic questions of international trade theory. This presentation examines the development of trade theory from the mercantilists to Adam Smith and David Ricardo, and seeks to answer the basic questions. (1) What is the basis for trade and what are the gains from trade? (2) What is the pattern of trade?TRANSCRIPT
International Trade TheoryInternational Trade Theory
The Law of Comparative AdvantageThe Law of Comparative Advantage
MC 2009
slide 2
OUTLINEOUTLINE
2.1 Introduction 2.2 The Mercantilists’ Views on Trade 2.3 Trade Based on Absolute Advantage: Adam Smith 2.4 Trade Based on Comparative Advantage: David Ricardo 2.5 Comparative Advantage and Opportunity Costs 2.6 The Impact of Trade
2.7 Empirical Tests of the Ricardian Model
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2.1 Introduction2.1 Introduction
Two Basic questions of international trade theory.
This presentation examines the development of trade theory from the mercantilists to Adam Smith and David Ricardo, and seeks to answer the basic questions.
(1) What is the basis for trade and what are the gains from trade?
(2) What is the pattern of trade?
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Export pattern of KoreaExport pattern of Korea
Rank1970 1980 1990 2000 2006
Item Share Item Share Item Share Item Share Item Share
1 Textiles 40.8 Garments 16.0 Garments 11.7 Semiconductor 15.1 Semiconductor 12.8
2 Plywood 11.0 Steel Plate-rolled Products 5.4 Semiconductor 7.0 Computer 8.5 Automobile 9.5
3 Wigs 10.8 Footwear 5.2 Footwear 6.6 Automobile 7.7 Wireless telecom 8.3
4 Iron ores 5.9 Vessel 3.6 Video Apparatus 5.6 Petrochemical products 5.3 Vessel 8.2
5 Electronic goods 3.5 Audio Apparatus 3.4 Vessel 4.4 Vessel 4.9 Petrochemical
products 4.2
6 Confectionery 2.3 Man made filament fabrics 3.2 Computer 3.9 Wireless telecom 4.6 Steel Plate-rolled
Products 3.9
7 Footwears 2.1 Rubber Products 2.9 Audio Apparatus 3.8 Synthetic Resin 2.9 Computer 3.9
8 Tobaccos 1.6 Woods & Wood items 2.8 Steel Plate-rolled
Products 3.8 Steel Plate-rolled Products 2.8 Flat penal
display 3.9
9 Iron products 1.5 Video Apparatus 2.6 Man made filament fabrics 3.6 Garments 2.7 Synthetic Resin 3.4
10 Metal products 1.5 Semiconductor 2.5 Automobile 3.0 Video Apparatus 2.1 Parts of Automobile 3.3
Total 81.1 47.6 53.4 56.6 60.0
Rank1970 1980 1990 2000 2006
Item Share Item Share Item Share Item Share Item Share
1 Textiles 40.8 Garments 16.0 Garments 11.7 Semiconductor 15.1 Semiconductor 12.8
2 Plywood 11.0 Steel Plate-rolled Products 5.4 Semiconductor 7.0 Computer 8.5 Automobile 9.5
3 Wigs 10.8 Footwear 5.2 Footwear 6.6 Automobile 7.7 Wireless telecom 8.3
4 Iron ores 5.9 Vessel 3.6 Video Apparatus 5.6 Petrochemical products 5.3 Vessel 8.2
5 Electronic goods 3.5 Audio Apparatus 3.4 Vessel 4.4 Vessel 4.9 Petrochemical
products 4.2
6 Confectionery 2.3 Man made filament fabrics 3.2 Computer 3.9 Wireless telecom 4.6 Steel Plate-rolled
Products 3.9
7 Footwears 2.1 Rubber Products 2.9 Audio Apparatus 3.8 Synthetic Resin 2.9 Computer 3.9
8 Tobaccos 1.6 Woods & Wood items 2.8 Steel Plate-rolled
Products 3.8 Steel Plate-rolled Products 2.8 Flat penal
display 3.9
9 Iron products 1.5 Video Apparatus 2.6 Man made filament fabrics 3.6 Garments 2.7 Synthetic Resin 3.4
10 Metal products 1.5 Semiconductor 2.5 Automobile 3.0 Video Apparatus 2.1 Parts of Automobile 3.3
Total 81.1 47.6 53.4 56.6 60.0
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2.2 2.2 The MercantilistsThe Mercantilists’’ Views on Trade Views on Trade
The more gold and silver a nation had, the richer and more powerful it was.
Thus the way for a nation to become rich is to export more than it imported.
The resulting export surplus would then be settled by an inflow of precious metals such as gold and silver.
Thus the mercantilists advocated restrictions on imports and incentives for exports.
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2.2 2.2 The MercantilistsThe Mercantilists’’ Views on Trade Views on Trade
A nation can gain in international trade only at the expense of other nations.
i.e., “Trade is a zero-sum game.”
Criticism: (1) The measure of the wealth of a nation? (2) Rulers vs. common people
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2.3 2.3 Trade Based on Absolute Advantage: Trade Based on Absolute Advantage: Adam SmithAdam Smith
Adam Smith, The Wealth of Nations, 1776.
2.3A. Absolute Advantage
When one nation is more efficient than (or has an absolute advantage over) another in the production of one commodity but is less efficient than (or has an absolute disadvantage with respect to) the other nation in producing a second commodity, …
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2.3 2.3 Trade Based on Absolute Advantage: Trade Based on Absolute Advantage: Adam SmithAdam Smith
…then both nations can gain by each specializing in the production of the commodity of its absolute advantage and exchanging part of its output with the other nation for the commodity of its absolute disadvantage.
Examples: (1) Nations (2) Individuals Thus, Adam Smith believed that all nations would gain
from free trade and strongly advocated a policy of laissez-faire and free trade.
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2.3 2.3 Trade Based on Absolute Advantage: Trade Based on Absolute Advantage: Adam SmithAdam Smith
2.3B. Illustration
The U.S. is more efficient than (or has an absolute advantage over) the U.K. in the production of Wheat but is less efficient than (or has an absolute disadvantage with respect to) the U.K. in producing Cloth.
U.S. U.K. Wheat (bushels/hour) 6 1
Cloth (yards/hour) 4 5
Table 1 The number of units produced by each hour of labor time
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2.3 2.3 Trade Based on Absolute Advantage: Trade Based on Absolute Advantage: Adam SmithAdam Smith
With trade, the U.S. would specialize in the production of wheat and exchange part of it for British cloth.
The opposite is true for the U.K.
Note: Absolute advantage can explain only a very small part of world trade.
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2.4 2.4 Trade Based on Comparative Advantage: Trade Based on Comparative Advantage: David Ricardo David Ricardo
David Ricardo, Principles of Political Economy and Taxation, 1817.
The Law of Comparative Advantage If one nation has an absolute disadvantage with respect to
the other nation in the production of both commodities, the first nation should specialize in the production of and export the commodity in which its absolute disadvantage is small (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage).
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IllustrationSuppose there are two countries of equal size, Northland and Southland, that both produce and consume two goods, Wheat and Jeans. The productive capacities and efficiencies of the countries are such that if both countries devoted all their resources to Wheat production, output would be as follows:
Northland: 100 tonnes Southland: 400 tonnes If all the resources of the countries were allocated to the production of Jeans, output would be:Northland: 100 tonnes Southland: 200 tonnes
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The Opportunity Cost TheoryThe cost of a good is the amount of a second good that must be given up to release just enough resources to produce one additional unit of the first good.Northland's opportunity cost of producing one tonne of Wheat is one tonne of Jeans and vice versa.Southland's opportunity cost of one tonne of Wheat is 0.5 tonne of Jeans. The opportunity cost of one tonne of Jeans is 2 tonnes of Wheat.
Northland has a comparative advantage over Southland in the production of jeans, the opportunity cost of which is higher in Southland with respect to wheat than in Northland.
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2.4 2.4 Trade Based on Comparative Advantage: Trade Based on Comparative Advantage: David Ricardo David Ricardo
Illustration:
Different opportunity cost lead to mutual benefit, if countries specialize.
Wheat Jeans
Northland 50 50
Southland 200 100
Total 250 150
Production and consumption before trade
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Trade Based on Comparative Advantage:Trade Based on Comparative Advantage:
Wheat JeansNorthland 0 100Southland 300 50Total 300 150
Production after trade
Wheat JeansNorthland 75 50
Southland 225 100
Total 300 150
Consumption after trade: (Exchange rate: 1 tonne of Wheat for 2/3 tonne of Jeans)
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2.5 Comparative Advantage and Opportunity 2.5 Comparative Advantage and Opportunity Costs Costs
Assumptions of the Ricardian Model 1) Only two nations and two goods2) Free trade3) Perfect mobility of labor within each nation but
immobility between the two nations4) Constant costs of production5) No transportation costs6) No technical change
Both countries benefit, and now consume at points outside their production possibility frontiers.
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2.6 The Impact of Trade2.6 The Impact of Trade
C D
F
Demand
Supply
$350
$250
A B
E
Supply
Demand
150200 300
160250 310
China United States
Thousands of Suits
per Month
Price(Dollars)
Price(Dollars)
Thousands of Suits
per Month
Exports
$350
$500
Imports
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2.6 The Impact of Trade in the 2.6 The Impact of Trade in the Exporting/Importing CountryExporting/Importing Country
When opening of trade results in increased exports of a good– Producers of the good are made better off– Consumers of the good in exporting country will be
made worse off When opening of trade results in increased imports of a
product– Domestic producers of the product are made worse
off– Consumers of the good in importing country are
better off