International Trade Theories: Absolute & Comparative Advantage, Opportunity Cost, and Production Curves

Absolute cost advantage

A country is expected to export those goods

absolute cost disadvantage

A country is expected to import those goods

Opportunity Cost

the loss of potential gain from other alternatives when one alternative is chosen.

Comparative advantage

•A country will export products that it can produce at a low opportunity cost (in terms of other goods that could be produced within the country).

•A country will import products that it would otherwise produce at a high opportunity cost.

The production-possibility curve (ppc)

shows all combinations of amounts of different products that an economy can produce with full employment of its resources and maximum feasible productivity of these resources.

Indifference curves

show the various combinations of consumption quantities that lead to the same level of well-being or happiness (utility).

labor-abundant

•it has a higher ratio of labor to other factors than does the rest of the world.

labor-intensive

labor costs are a greater share of its value than they are of the value of other products.

Factor Price equalization theorem

given certain conditions and assumptions, free trade equalizes not only product prices but also the prices of individual factors between the two countries.

Example)

•Laborers (of the same skill level) earn the same wage rate in both countries.

•Units of land (of comparable quality) earn the same rental return in both countries.

The Stolper-Samuelson Theorem

given certain conditions and assumptions, including full adjustment to a new long-run equilibrium, an event that changes relative product prices in a country unambiguously has two effects:

1.It raises the real return to the factor used intensively in the rising-price industry.

2.It lowers the real return to the factor used intensively in the falling-price industry.

According to compartive advantage

•Countries that are similar should trade little with each other.

•Each country should export some products (if the country has a relative cost advantage) and import other products (if the country has a relative cost disadvantage).

Scale Economies

the cost advantages that occur when producing more lowers the average cost per unit, because output grows faster than total cost. For example, a car factory that doubles production might not need to double its workers or machines—so the cost per car falls as more cars are made

External scale of economies

are based on the size of an entire industry within a specific geographic area.

The average cost of the typical firm producing the product in this area declines as the output of the industry (all the local firms producing this product) within the

Oligopoly

If a few large firms dominate the global industry, perhaps because of substantial scale economies

Monopoly

Complete control of a product or business by one person or group

Monopolistic competition

•where a large number of firms compete vigorously with each other in producing and selling varieties of the basic product.

Rybczynski theorem

and assuming that product prices are constant, growth in the country's endowment of one factor of production, with the other factor unchanged, has two results:

•An increase in the output of the good that uses the growing factor intensively.

A decrease in the output of the other good.

Immiserizing growth

Growth that expands the country's willingness to trade can result in such a large decline in the country's terms of trade that the country is worse off.

Small countries do not experience this

Product differentiation:

•Many different types and varieties of a product may exist.

Production possibility frontier

shows the maximum possible combinations of two goods or services that can be produced with a fixed amount of resources and technology.

economic growth

an increase in the amount of goods and services produced per head of the population over a period of time.

Intra-industrty trade:

This is two-way trade in which a country both exports and imports the same or very similar products (products in the same industry).

If quantity supplied is bigger than quantity demanded

Exporter

H-O Theorem

countries will export goods that use their relatively abundant factors of production intensively and import goods that use their relatively scarce factors intensively.

internal scale of economies

•the size of the individual firm matters, that is, larger firms have a cost advantage over smaller firms.

• can drive an industry away from perfect competition, because they drive individual firms to be larger than the (very) small firms that populate perfectly competitive industries.

inter industry trade

•A country exports products in some industries and imports products in other industries. For each industry, net trade is either (almost) all exports or (almost) all imports.

The Stolper-Samuelson Theorem

It raises the real return to the factor used intensively in the rising-price industry.

It lowers the real return to the factor used intensively in the falling-price industry.

Countrys term of trade

Price level (exports) / price level (imports)