The Gains from

1
The Gains from
International
Trade
2
Overview of the Field of International Economics

• International Trade
• gains from trade
• comparative advantage
• trade barriers
• example quotas

• International Finance
• exchange rates
• trade deficits or surpluses
• a macroeconomic topic taken up in later lectures

3
Globalization of the Economy

• Recent high growth of international trade
• reduced transportation costs
• lower barriers to trade
• Look around you for many examples
• todays news
• this computer

4
Four ways to gain from trade

• voluntary exchange (already discussed)
• competition (already discussed)
• economies of scale (next lecture)
• comparative advantage (this lecture)

5
Definitions

• Absolute advantage a country can produce a good
  relatively more efficiently than another country
  (example U.S. better at oranges than Canada)
• Comparative Advantage a country can produce a
  good relatively more efficiently than another
  good in comparison with another country
• Applies to people as well as to countries

6
Numerical example Output per day of work
7
Find who has a comparative advantage in what

• US has an absolute advantage over K in both
  vaccine and TV sets
• for Vaccine 6gt1, for TV sets 3gt2
• US has a comparative advantage in vaccines
• 6/1 is greater than 3/2
• K has a comparative advantage in TV sets
• 2/3 is greater than 1/6

8
Can define comparative advantage in terms of
opportunity costs

• Definition If country A has a lower opportunity
  cost of producing a good, then it has a
  comparative advantage in that good compared to
  country B
• Example. Opportunity cost of producing a TV in US
  is 2 vials while it is only 1/2 vial in Korea
• Hence, Korea has the comparative advantage in TVs

9
To get a gut-feeling for the idea of comparative
advantage, lets imagine 2 people with 2 skills
lawyer economist
10
Like two people, two countries can gain from
trade based on comparative advantage. To see
this, assume that the price with trade is 1 unit
of vaccine for 1 TV set

• How can the US gain from trade?
• reduce TV production by 3
• increase vaccine production by 6
• trade with K for 6 TV sets
• come out ahead by 3 TV sets

11
Korea can also gain from trade

• increase TV production by 6
• reduce vaccine production by 3,
• trade with US for 6 vials of vaccine
• come out ahead by 3 vials of vaccine

12
Determining the price ratio before trade

• United States
• in the US, 6 vials cost the same to produce as 3
  TVs
• Thus, TVs should cost twice as much as vials
• ratio of PTV to P v 2

• Korea
• in Korea, 2 TVs cost the same to produce as 1
  vial
• Thus TVs should cost half as much as vials
• ratio of PTV to P v 1/2

13
Determining the price ratio after trade

• Price ratio must come together somewhere between
  2 and 1/2
• We cannot tell exactly what the price ratio will
  be
• it depends on demand
• For ease of multiplication, we therefore assume
  that the price ratio is 1
• that is, the ratio of PTV to P v 1

14
Showing Comparative Advantage with Production
Possibilities Curves(10,000 workers in US and
30,000 in K)
15
Do you think you could sketch that diagram by
hand?
16
End of Lecture