international econ PPT 3

Theories of why trade occurs:

•Differences across countries in labor, labor skills, physical capital, natural resources, and technology

•Economies of scale (larger scale of production is more efficient)

•Sources of differences across countries that lead to gains from trade:

The Ricardian model (Chapter 3)

examines differences in theproductivity of labor (due to differences in technology) between countries.

The Heckscher-Ohlin model (Chapter 4)

examines differences in labor, labor skills, physical capital, land, or other factors of production between countries.

Ricardian model

The ___ uses the concepts of opportunity cost and comparative advantage.

Comparative Advantage and Opportunity Cost

The opportunity cost of producing something measures the cost of not being able to produce something else with the resourced used

•For example, a limited number of workers could produce either roses or computers.

•The opportunity cost of producing computers is the amount of roses not produced.

•The opportunity cost of producing roses is the amount of computers not produced.

Example

Suppose that in the U.S. 10 million roses could be produced with the same resources that could produce 100,000 computers.

•Suppose that in Colombia 10 million roses could be produced with the same resources that could produce 30,000 computers.

•Workers in Columbia would be less productive than those in the U.S. in manufacturing computers.

Colombia has a lower opportunity cost of producing roses.

•Colombia can produce 10 million roses, compared to 30,000 computers that it could otherwise produce.

•The U.S. can produce 10 million roses, compared to 100,000 computers that it could otherwise produce.

The U.S. has a lower opportunity cost of producing computers.

•Colombia can produce 30,000 computers, compared to 10 million roses that it could otherwise produce.

•The U.S. can produce 100,000 computers, compared to 10 million roses that it could otherwise produce.

•The U.S. can produce 30,000 computers, compared to 3.3 million roses that it could otherwise produce.

Conclusion

Lower opportunity cost kung saan sila dapat mag focus in producing

 

comparative advantage

A country has a ___ in producing a good if the opportunity cost of producing that good is lower in the country than in other countries.

•The U.S. has a comparative advantage in computer production.

•Colombia has a comparative advantage in rose production

Conclusion

Kung saan sila lower opportunity cost dun sila mag ffocus diba, yun din yung comparatively advantage nya

True

When countries specialize in production in which they have a comparative advantage, more goods and services can be produced and consumed.

•Have U.S. stop growing roses and use those resources to make 100,000 computers instead. Have Colombia stop making 30,000 computers and grow roses instead.

One-Factor Ricardian Model

•The simple example with roses and computers explains the intuition behind the Ricardian model.

•We formalize these ideas by constructing a ____ using the following assumptions:

1.Labor is the only factor of production.

2.Labor productivity varies across countries due to differences in technology, but labor productivity in each country is constant.

3.The supply of labor in each country is constant.

unit labor requirement

A ___ indicates the constant number of hours of labor required to produce one unit of output.

low labor productivity.

A high unit labor requirement means ____

Production Possibilities

•shows the maximum amount of a goods that can be produced for a fixed amount of resources.

Trade in the Ricardian Model

•Suppose the home country is more efficient in wine and cheese production.

•It has an absolute advantage in all production: its unit labor requirements for wine and cheese production are lower than those in the foreign country:

   aLC < a*LC and aLW < a*LW

•A country can be more efficient in producing both goods, but it will have a comparative advantage in only one good.

•Even if a country is the most (or least) efficient producer of all goods, it still can benefit from trade.

 

•Suppose that the home country has a comparative advantage in cheese production: its opportunity cost of producing cheese is lower than in the foreign country.

aLC /aLW < a*LC /a*LW

 

   where “*” notates foreign country variables

 

•When the home country increases cheese produc

Gains from trade

____ come from specializing in the type of production which uses resources most efficiently, and using the income generated from that production to buy the goods and services that countries desire.

Without trade

____, a country has to allocate resources to produce all of the goods that it wants to consume.

With trade

, a country can specialize its production and exchange for the mix of goods that it wants to consume.

True

Consumption possibilities expand beyond the production possibility frontier when trade is allowed.

True

With trade, consumption in each country is expanded because world production is expanded when each country specializes in producing the good in which it has a comparative advantage

Relative wages

➢are the wages of the home country relative to the wages in the foreign country.

Evidence

shows that low wages are associated with low productivity.

Wage

___ of most countries relative to the U.S. is similar to their productivity relative to the U.S.

 

Misconceptions About Comparative Advantage

Free trade is beneficial only if a country is more productive than foreign countries.

Misconceptions About Comparative Advantage

Free trade with countries that pay low wages hurts high wage countries.

Misconceptions About Comparative Advantage

Free trade exploits less productive countries.

True

Differences in the productivity of labor across countries generate comparative advantage.

True

A country has a comparative advantage in producing a good when its opportunity cost of producing that good is lower than in other countries.

True

Countries export goods in which they have a comparative advantage - high productivity or low wages give countries a cost advantage.

True

With trade, the relative price settles in between what the relative prices were in each country before trade.