Lecture 7: Why Countries Trade

Why countries trade

• differences in factor endowments

  • natural resources, climate, terrain, labor force, capital, tech

Agglomeration economies

firms want to be in certain locations to take advantage of activities occurring in those places — e.g Hollywood, Silicon Valley, etc

Standard H-O Model

Because countries are relatively more efficient (advantaged) in the production of certain goods and disadvantaged in others due to their factor endowments, mutual gains from trade will occur when products are redistributed so countries end up with a combo of goods better adapted to their preferences

*assumes everything about the production process in the two countries is the same except for the factor endowments

*production table shows max output if all workers are employed

Mutual gains from trade

when products are redistributed such that countries end up with a combination of goods better adapted to their preferences than what they had before — specialization! e.g. bread and wine or microchip and breadbasket example

**assume everything is the same

Absolute advantage

when a country can produce a good using smaller quantities of resources than can the other country

Comparative advantage

when a country makes the good that it is least disadvantaged in producing because the other country has an absolute advantage in the production of both goods

• if countries specialize in producing the goods in which they are relatively more efficient, trade can lead to mutual gains

Geometry of trade

Slope of production possibilities frontier = opportunity cost!!

Arithmetic of comparative advantage

adds consumption as a factor

Competitive advantage

competition between firms in a country can be good for encouraging innovation

for pillars:

• factor conditions (LLK, tech, infrastructure)

• demand (market) conditions

• supporting industries

• firm strategy, structure, competition