introduction classical economics and comparative advantage analysis of comparative advantage
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International Trade & the World Economy; Charles van Marrewijk. CHAPTER 3; COMPARATIVE ADVANTAGE. Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade - PowerPoint PPT PresentationTRANSCRIPT
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Explanations for trade
Classical 2. Opportunity costs 3. Comparative advantage
Neo-classical 4. Production structure 5. Factor prices 6. Production volume 7. Factor abundance
New trade 9. Imperfect competition 10. Intra-industry trade
Policy
8. Trade policy
11. Strategic trade policy
12. Int. trade organizations 13. Economic integration
17. Applied trade policy modeling
Economicgeography
New interactions 14. Geographical economics 15. Multinationals 16. New goods, growth, and development
Industrialorganization
Internationalbusiness
Growth theory
Par
t I
Part
II
Part
III
Part
IV
18. Concluding remarks
1. The world economy
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Introduction International Trade & the World Economy; Charles van Marrewijk
Objectives / key terms
Comparative advantage Production possibility frontier (ppf)
Autarky Terms of trade
Gains from trade World ppf
David Ricardo (1772-1823)
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Classical economics and comparative advantage International Trade & the World Economy; Charles van Marrewijk
One of the few ideas in economics that is true without being obvious
According to Paul Samuelson (1915-; Nobel prize 1970) the theory of comparative advantage is
Technological differences between nations are the classical driving force behind international trade flows.
According to David Ricardo relative or comparative differences are important, not absolute differences.
The idea of comparative advantage is often misunderstood, see
Paul Krugman (1953-) “Ricardo’s difficult idea”
at http://web.mit.edu/krugman/www
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
• 2 countries; EU and Kenya
International trade based on differences in technology assumptions
• No transport costs
• 2 goods; Food and Chemicals
• 1 factor of production; labor L
• Constant returns to scale; CRS
• Labor mobility between sectors, not between countries
• Perfect competition
unit labor requirement = units of labor required to produce one
unit of a final good By assumption this is independent of the
number of laborers active in a sector (CRS), but may differ between the two countries.Let be the for good F in EU, etcunit labor requirement EU
Fa
International Trade & the World Economy; Charles van Marrewijk
Analysis of comparative advantage
Productivity table to summarize the state of technology
Note that the EU is more efficient than Kenya in the production of both goods, requiring 2 < 4 laborers for Food and 8 < 24 laborers for Chemicals. Why would the EU trade with Kenya?
Note: EU is twice more productive in Food, and three times in Chem.
In autarky (without international trade) both countries will produce both goods if consumers demand both Food and Chemicals.
International Trade & the World Economy; Charles van Marrewijk
Analysis of comparative advantage
Table 3.1 Productivity table; labor required to produce 1 unit of output
General specification Example
Food Chemicals Food Chemicals
EU EUFa
EUCa EU 2 8
Kenya KFa
KCa Kenya 4 24
According to David Ricardo both countries can gain from international trade through specialization (EU producing more chemicals and Kenya producing more food):
Suppose Kenya produces 1 chemical less, this frees up 24 laborers.
These 24 laborers can now produce 24/4 = 6 units of food
To keep the production level of chemicals constant, the EU should make 1 chemical more. This requires 8 laborers.
These 8 laborers could have made 8/2 = 4 units of food.
Conclusion: EU Kenya change world prod.
production of chem. +1 -1 0
production of food -4 +6 +2
The extra production represents gains from trade
International Trade & the World Economy; Charles van Marrewijk
Analysis of comparative advantage
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Production possibility frontier and autarky International Trade & the World Economy; Charles van Marrewijk
Production possibility frontier (ppf) = All possible combinations of efficient production points given the available factors of production and the state of technology. Note:
• ppf depends on available factors of production
• ppf depends on state of technology
• ppf does not depend on type of market competition
Table 3.2 Total labor available and maximum production levels
Total labor Maximum production
available Food Chemicals
EU 200 EU 100 25
Kenya 120 Kenya 30 5
Production possibility frontier and autarky International Trade & the World Economy; Charles van Marrewijk
Food
Chemicals0
30
255
100
Kenya ppf
EU ppf
A
B
CE
D
Autarky prod. and cons. along ppf (determines autarky price ratio)
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Terms of trade and gains from trade International Trade & the World Economy; Charles van Marrewijk
Food
Chemicals0
30
255
100
Kenya ppf
EU ppf
A
B
F
Kenyabudgetline
6.25
120
G
EU budgetline
Both countries gain if international price is in between autarky prices
Terms of trade is 4.8 food per unit of chemicals
Terms of trade and gains from trade International Trade & the World Economy; Charles van Marrewijk
Food
Chemicals0
30
255
100
Kenya ppf
EU ppf
A
B
F
Kenyabudgetline
7.5
120
EU budgetline
Only Kenya gains if international price is equal to EU autarky price
Terms of trade is 4 food per unit of chemicals
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
Application: Kenya and the EU International Trade & the World Economy; Charles van Marrewijk
Not all exports behave in accordance with comparative advantage (but explains more trade flows than absolute advantage)
-50
0
50
100
0 50 100 150 200
Relative productivity ratio (Kenya/EU); %
Ken
ya e
xpor
t (%
) -
impo
rt (
%)
food
chemicalsmachinery
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
More countries and world ppfInternational Trade & the World Economy; Charles van Marrewijk
Food
Chemicals
C
B
Country B and C ppf
Food
Chemicals
D
A
Country A and D ppf
If we identify more countries and two goods we can calculate individual ppf’s with a slope depending on comparative advantage.
Combining these in a world ppf gives rise to a concave frontier (next slide)
More countries and world ppfInternational Trade & the World Economy; Charles van Marrewijk
F o o d
C h e m i c a l s0
A
B
C
D
00 / fc ppslope
11 / fc ppslope
E 0
E 1
W o r l d p p f
C m a x
F m a x
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
The Balassa index II International Trade & the World Economy; Charles van Marrewijk
The Ottens (2000) calculations of the Balassa index uses the OECD countries as reference. Sometimes all countries in the world are used.
Hinloopen and van Marrewijk (2001) use data on EU exports for 98 sectors to Japan to calculate the Balassa index, such that:
similar trade policy access to the Japanese for all countries
similar development levels for the EU countries
similar distance (physical and pecuniary costs) for all countries
which supposedly results in a ‘cleaner’ measure of comparative advantage and the probability density function of the Balassa index as depicted on the next slide.
0.04 0.68 1.32 1.96 2.60 3.24 3.88
Balassa-index
frequency
The Balassa index II International Trade & the World Economy; Charles van Marrewijk
The probability density function of the Balassa-index based on monthly-moving annual observations (restricted to 0 BI 4)source: Hinloopen and van Marrewijk (2001)
Introduction
Classical economics and comparative advantage
Analysis of comparative advantage
Production possibility frontier and autarky
Terms of trade and gains from trade
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
CHAPTER 3; COMPARATIVE ADVANTAGEInternational Trade & the World Economy; Charles van Marrewijk
ConclusionsInternational Trade & the World Economy; Charles van Marrewijk
Technological differences between countries are the classical driving force for international trade flows.
Only comparative costs, not absolute costs, are important for determining the direction of trade flows.
Absolute costs are important for determining a country’s welfare level.
Empirically, comparative costs performs somewhat better than absolute costs.
Allowing for more countries and more goods is easy, allowing for more than one factor of production is not (see part II).