benfits of international trade

Gains from International Trade and Comparative Advantage

Introduction to Comparative Advantage

  • Comparative Advantage Definition: A concept in economics that highlights how countries can benefit from trade by specializing in the production of goods where they hold a relative efficiency advantage compared to other countries.

Absolute Advantage

  • Absolute Advantage Definition: A situation where a country can produce a good more efficiently than another country.
    • Example: If Country A can produce 10 units of a product with the same resources that Country B uses to produce only 5 units, Country A has an absolute advantage.

Comparison of Comparative and Absolute Advantage

  • Distinction: Comparative advantage focuses on the relative efficiency of producing two goods between different countries, whereas absolute advantage focuses solely on overall productivity.

Example: The United States and Korea

  • Consider two goods: Vaccines and TV Sets.
  • Production Output:
    • United States:
    • 1 day of work produces 6 units of vaccines
    • 1 day of work produces 3 TV sets
    • Korea:
    • 1 day of work produces 1 unit of vaccine
    • 1 day of work produces 2 TV sets
Analysis of Absolute Advantage in the Example
  • United States shows absolute advantage in:
    • Vaccines: 6 (US) vs 1 (Korea)
    • TV Sets: 3 (US) vs 2 (Korea)
Determining Comparative Advantage
  • Calculating Comparative Advantage:
    • To find out comparative advantages, we compute the opportunity costs:
    • For the US:
      • Opportunity cost of 1 unit of vaccine = 0.5 TV sets (3 TV sets / 6 vaccines)
      • Opportunity cost of 1 TV set = 2 vaccines (6 vaccines / 3 TV sets)
    • For Korea:
      • Opportunity cost of 1 unit of vaccine = 2 TV sets (2 TV sets / 1 vaccine)
      • Opportunity cost of 1 TV set = 0.5 vaccines (1 vaccine / 2 TV sets)
Conclusion of Comparative Advantage in Example
  • The US has a comparative advantage in vaccines (lower opportunity cost of producing vaccines).
  • Korea has a comparative advantage in TV sets.

Gains from Trade

  • Exchange Scenario:
    • Assume both vaccines and TV sets have a price of $100 each (1:1 exchange ratio).
  • US Gains from Trade:
    • Instead of producing all TV sets, US reallocates workers to increase vaccine production.
    • Reduction in TV production = 3 units
    • Increase in vaccine production = 6 units.
    • Trade 6 vaccines for 6 TV sets; thus, the US ends up with 3 more TV sets than without trade.
Example Breakdown for Korea
  • Assume Korea reallocates its workforce:
    • Decrease in vaccine production; increase in TV production (6 TV sets produced instead of vaccines).
    • Trades 6 TV sets for 6 vaccine units; ends with 3 more vaccine units than before.

Production Possibilities Curves (PPC)

  • Assumptions for Production:
    • US has 10,000 workers: can either produce vaccines or TVs.
    • Korea has 30,000 workers: can also produce either vaccines or TVs.
  • Production Possibilities for the US:
    • If all resources dedicated to vaccines: 60,000 units.
    • If all resources dedicated to TVs: 30,000 units.
  • Production Possibilities for Korea:
    • If all resources dedicated to vaccines: 30,000 units.
    • If all resources dedicated to TVs: 60,000 units.
Illustrating Production Possibilities
  • Graphical Representation:
    • US PPC plotted with vaccines on the vertical axis and TVs on the horizontal axis.
    • Korea PPC plotted similarly.
  • Visualization shows how both countries can adjust and specialize based on comparative advantages.

Impact of Trade on Consumption Possibilities

  • Specialization and Trade Benefits:
    • If the US specializes in vaccines, it can produce 60,000 vaccines and consume more TVs by trading with Korea.
    • Conversely, if Korea specializes in TV production, it can trade for vaccines, thus shifting their consumption possibilities outward beyond their individual production possibilities.
  • Concept Understanding:
    • Trade effectively acts as if a new technology has been invented, allowing both countries to consume beyond their initial production capabilities.

Conclusion

  • The mutual gains from trade emphasize the importance of specialization based on comparative advantage, demonstrating how countries can enhance their productivity and consumption through international trade.