International economics

Factor availabilityPugel Ch. 4

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Summary: absolute advantage

• A country enjoys an absolute advantage over country B in the production of product X when – One worker in country A produces more units

of X in one hour than that of in country B does.

– One worker in country A needs less hours to make one unit of X than one worker needs in country B.

Summary: comparative advantage

• Country A enjoys a comparative advantage in the production of good X when– It has a relative advantage in labour

productivity – bigger absolute advantage or – less absolute disadvantage

• Assumption: 2 countries (A and B), 2 products (x and y)

Summary: comparative advantage

• Calculation (Px stands for labour productivity for x or output of x per hour):– Px/Py(A) > Px/Py(B) means that country A

has a comparative advantage in producing x– PA/PB(x) > PA/PB(y) means that country A

has a comparative advantage in producing x

Factor availability

• New assumptions:– Two factors (usually capital : K and labour : L)– Increasing marginal costs of production

instead of constant marginal costs (Ricardo’s approach)

• MRT (marginal rate of transformation) is not constant on the PPC curve (bowed)MRTyx = -Δy / Δx

• S1: MRTcw=-1W/C• S0: MRTcw=-2W/C• S2: MRTcw=-3W/C

• In S1: to produce 1 unit cloth we pass up producing 1 unit of wheat

• In S2: for 1 unit cloth we give up producing 2 units of wheat

National level

• Suppose that the market price of cloth in terms of wheat is 2 W/C.– If the opportunity cost of producing another unit of

cloth is less than 2 W/C (S1) -> make more cloth– If the opportunity cost of producing another unit of

cloth is more than 2 W/C (S2) -> make less cloth– If the opportunity cost of producing another unit of

cloth is equal to 2 W/C (S0) -> right amount of cloth

• Budget constraint: Y=Pw · Qw + Pc · Qc

National level, no trade