comparative advantage and the gains from trade · 2017-09-29 · title: microsoft powerpoint -...
TRANSCRIPT
Chapter 3
Comparative
Advantage
and the Gains
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and the Gains
from Trade
Chapter Objectives
• Introduce the theory of comparative advantage
• Show how nations maximize material welfare by
specializing in goods and services
• Discuss how gains from trade can improve
national welfare
• Introduce the distinction between comparative
advantage and competitiveness
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Introduction: The Gains from Trade
• The improvement in national welfare is • The improvement in national welfare is
known as the gains from trade
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Adam Smith and the
Attack on Economic Nationalism
• In 1776, Adam Smith published the first modern statement of
economic theory, An Inquiry into the Nature and Causes of the
Wealth of Nations
– The Wealth of Nations attacked mercantilism—the system
of nationalistic economics that dominated economic
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of nationalistic economics that dominated economic
thought in the 1700s
– Smith proved wrong the belief that trade was a zero sum
game—that the gain of one nation from trade was the loss
of another
– Voluntary exchange (trade) is a positive sum game —both
nations gain
Implications of Adam Smith’s Theory
• Access to foreign markets helps create wealth
– If no nation imports, every company will be limited by
the size of its home country market
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– Imports enable a country to obtain goods that it cannot
make itself or can make only at very high costs
– Trade barriers decrease the size of the potential market,
hampering the prospects of specialization, technological
progress, mutually beneficial exchange, and, ultimately,
wealth creation
Adam Smith and Trade Barriers
• Smith was highly critical of trade barriers
• Trade barriers decrease
- Specialization- Specialization
- Technological progress
- Wealth creation
• The modern view of trade shares Smith’s dislike
for trade barriers
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A Simple Model of Production
and Trade
• A basic model, often referred to as the Ricardian model, named after economist David Ricardo
• Assumptions
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• Assumptions
– Markets are competitive: Firms are price takers
– Static world: Technology is constant and there are no learning effects
– Labor is perfectly mobile: It can easily move back and forth between industries
Absolute Productivity Advantage
and the Gains from Trade
– Productivity: The amount of output obtained from a unit of input
– Labor productivity:(units of output) / (hours worked)
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(units of output) / (hours worked)If two loaves of bread can be produced in 1 hour, productivity = (2 loaves) / (1 hour)
– Absolute productivity advantage: The advantage held by a country that produces more of a certain good per hour worked than another
TABLE 3.1 Output per Hour Worked
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Absolute Productivity Advantage and the
Gains from Trade (cont.)
• The U.S. opportunity cost of bread is 1.5 tons of steel:
each unit of bread produced requires the U.S. economy to
forfeit the production of 1.5 tons of steel
Pb =3 tons
= 1.5tons
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• In sum, trade between U.S. and Canada will occur at a
price between these two limits:
PUSb =
3 tons
2 loaves= 1.5
tons
loaves
3.0loaves
ton
>
W
S
P > 0.67loaves
ton
Comparative Productivity
Advantage and the Gains from
Trade (cont.)
• Question: What happens to a country that does not have absolute productivity advantage in anything?
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• Answer: Even if a country does not have any goods with an absolute productivity advantage, it can still benefit from trade
-The idea that nations benefit from trade has nothing to do with whether a country has an absolute advantage in producing a particular good
Table 3.2 Ten Largest Oil Reserves
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Production Possibilities Curve (PPC)
• A production possibilities curve (PPC)
shows the tradeoffs a country faces when
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shows the tradeoffs a country faces when
choosing between two goods
FIGURE 3.1
A Production Possibilities Curve for the United States
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FIGURE 3.2
Opportunity Costs and the Slope of the PPC
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What Determines the Slope of the PPC?
• Using Figure 3.2 as an example, the slope of the
PPC is -0.67: The number of loaves of bread
forgone divided by the quantity of steel obtained
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forgone divided by the quantity of steel obtained
Relative Prices
• Without trade, the U.S. would forgo 0.67 loaves of bread for an additional ton of steel. This is the opportunity cost of steel, or the relative price of steel
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• Why relative price? Because the price is not in monetary units but in units of the other good
-Relative price of steel is the inverse of the price of bread: if 0.67 loaves of bread is the price of a ton of steel in the U.S., then 1.5 tons of steel is the price of one loaf of bread
The Price Line or Trade Line
• Autarky: The complete absence of trade; all nations
can only consume the goods they produce at home
• Trade allows countries to raise their consumption
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• Example:– If the opportunity cost of steel in Canada is 3 loaves of bread per ton,
and in the U.S. 0.67 loaves per ton, both countries can consume more
by trading
– Gains from trade will occur if the price of steel settles somewhere
between the opportunity costs in Canada and the U.S.
3.0 (loaves/ton) >W
S
P > 0.67 (loaves/ton)
• Let the price of bread settle at 2 loaves per ton
• U.S. trading possibilities are illustrated by the price line or the trade
line (TT) with a slope of -2
• A = the combination of steel and bread available for trade
FIGURE 3.3
Production and Trade Before Specialization
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• By specializing in the production of steel and trading steel for bread, the U.S. receives gains from trade and can increase its consumption
• C = the consumption bundle the U.S. obtains by producing at B, or by specializing in steel and trading for bread
FIGURE 3.4 Production to Maximize Income
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FIGURE 3.5 Canada’s Gains from Trade
• Conversely, Canada, by specializing in the production of bread and trading for steel, can also increase its consumption
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The Gains from Trade
• In sum, suppose the relative price of steel is 2 loaves of bread
– When the U.S. increases steel output by 1 ton, it gives up 0.67
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– When the U.S. increases steel output by 1 ton, it gives up 0.67 loaves of bread output; however, it can now trade the steel for 2 loaves, leaving a net gain of 1.33 loaves (2 - 0.67 = 1.33)
– To meet U.S. demand for 2 more loaves of bread, Canada gives up 0.67 tons of steel output; however, it can now trade 2 loaves for 1 ton of steel, leaving a net gain of 0.33 tons (1 - 0.67 = 0.33)
3.0(loaves/ton) >W
S
P > 0.67(loaves/ton) ?
Domestic Prices and the Trade
Price
• How do we make sure that the trade price settles within
– If the trade price was 4 loaves of bread, both countries would specialize
in steel. However, the consequent bread shortage and steel glut would
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in steel. However, the consequent bread shortage and steel glut would
increase the price of bread and decrease the price of steel; once the
price of bread fell to less than 3.0, Canadian producers would switch
back to bread
– If trade price is closer to 0.67, gains are larger for Canada; if it is closer
to 3.0, gains are larger for the U.S.; however, both would gain from
trade when the price falls in this range
Absolute and Comparative
Productivity Advantage Contrasted
• Absolute productivity advantage: Held by a country that produces more of a certain good per hour worked than another
• Comparative productivity advantage (or
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• Comparative productivity advantage (or comparative advantage): Held by a country that has lower opportunity costs of producing a good than its trading partners do
• Comparative advantage allows a country that lacks absolute advantage to sell its products abroad
Gains from Trade with
No Absolute Advantage
• Japan has an absolute advantage in both cars (2>0.5) and
steel (3>1), yet it can still gain from trade, as can Malaysia
• Once trade opens, the world price of cars will be between
one and two tons of steel per car
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TABLE 3.3 Output per Hour Worked
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Table 3.4 Indicators of the Korean Economy
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Comparative Advantage and
“Competitiveness”
• Comparative advantage = competitive advantage
when the prices of both inputs and outputs are an
accurate indication of their relative scarcity
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• Comparative advantage ≠ competitive advantage
when the markets fail to correctly value the price of
inputs and outputs
-Imbalances result from government policies, such as
subsidies or protection
Economic Restructuring
• Economic restructuring: Changes in the economy that may require some industries to grow and others to shrink or disappear
– In the Ricardian model, trade opening moved labor from
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– In the Ricardian model, trade opening moved labor from bread to steel production: restructuring improved U.S. overall economic welfare but made its bread industry disappear
– If trade results in net gain (in an increase of the consumption bundle), a country will be better off by trading; however, some sectors may still lose
Economic Restructuring(cont.)
• Given that some lose due to economic restructuring, the government can seek to get the winners from trade and restructuring to compensate the losers
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– Trade adjustment assistance (TAA) helps losers by providing extended unemployment benefits, worker retraining, and temporary tax on imports
– For example, the U.S. government created a special program for workers laid off because of NAFTA; in 1994, 17,000 workers qualified for the program
Table 3.5 Low-Cost and High-Cost Cotton Producers
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Table 3.5 (continued) Low-Cost and High-Cost Cotton
Producers
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