Chapter 3
Why Everybody Trades: Comparative Advantage This chapter extends the analysis of international trade to consider trade in a multiple-product economy. An economy composed of two products is useful to bring out insights about international trade. This general equilibrium approach explicitly shows the effects of resource reallocations between industries. The chapter culminates in showing the importance of comparative advantage for understanding why countries trade.
Knowledge Points
The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world).
Why Everybody Trades: Comparative Advantage
The chapter uses the Ricardian example to introduce a key analytical device—the production possibility curve, which shows all combinations of outputs of different goods that an economy can produce with full employment of resources and maximum productivity. The resource costs of producing each product in the country and the total amount of labor hours available in the country are used to graph the country's production possibility curve, a straight line whose slope equals the (negative of the) extra (or marginal) cost of additional cloth.
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.
Cases
10.If the number of labor hours to make a bushel of wheat is reduced by half to 1 hour, this reinforces the U.S. comparative advantage in wheat. (In fact, the United States then has an absolute advantage in wheat.) The United States is still predicted to export wheat and import cloth. If, instead, the number of hours to make a yard of cloth is reduced by half to 2 hours, this reduces the U.S.
10.If the number of labor hours to make a bushel of wheat is reduced by half to 1 hour, this reinforces the U.S. comparative advantage in wheat. (In fact, the United States then has an absolute advantage in wheat.) The United States is still predicted to export wheat and import cloth. If, instead, the number of hours to make a yard of cloth is reduced by half to 2 hours, this reduces the U.S. absolute disadvantage in cloth, but it does not change the pattern of comparative advantage. The relative price of cloth is now 1 (=2/2) bushel per yard in the United States with no trade, but this is still higher than the price of 0.67 bushel per yard in the rest of the world. The United States still has a comparative advantage in wheat, so the United States is still predicted to export wheat and import cloth.
The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world).
The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world). Smith examined the case of absolute advantage, in which labor productivity in producing one product is higher in one country and labor productivity in producing the other product is higher in the other country. With no trade each country must produce both products to meet national demands. The discussion of the Smith case focuses on the increase in global production efficiency achieved by shifting production in each country toward the product in which it has the higher labor productivity. National demands can be met by international trad
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost.
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost. The Ricardian example is developed in more detail. The ratio of resource costs (labor hour input-output coefficients, the inverse of labor productivities) indicates the opportunity costs or relative prices of the products in each country with no trade. The difference in prices with no trade sets up the opportunity for arbitrage, with each good being exported from the initially low-price country and imported by the initially high-price country. The shift to a free trade equilibrium results in an equilibrium international price. Without informatio
2.Agree. Imports permit the country to consume more (or do more capital investment using imported capital goods). Anything that is exported is not available for domestic consumption (or capital investment). Although this loss is bad, exports are like a necessary evil because exports are how the country pays for the imports that it wants.
2.Agree. Imports permit the country to consume more (or do more capital investment using imported capital goods). Anything that is exported is not available for domestic consumption (or capital investment). Although this loss is bad, exports are like a necessary evil because exports are how the country pays for the imports that it wants.
Exercises
According to the Mercantilists, governments should
正确答案：B | subsidize and encourage exports.
难度：1 Easy Bloom's：Remember
________ wrote the Wealth of Nations.
正确答案：C | Adam Smith
难度：1 Easy Bloom's：Remember
When Adam Smith presented his theory of absolute advantage, he assumed that all "value" in an economy was determined by and measured in terms of the ________ used in the production of the various goods.
正确答案：B | labor hours
难度：1 Easy Bloom's：Remember
Labor productivity refers to:
正确答案：A | the number of units of output a worker can produce in one hour.
难度：1 Easy Bloom's：Remember
Which of the following is true of mercantilism?
正确答案：D | Mercantilism believed that national well-being was based on national holdings of gold and silver.
难度：1 Easy Bloom's：Remember
If Country X has higher labor productivity in the production of umbrellas than the rest of the world, we would say that Country X has a(n) ________ in the production of umbrellas.
正确答案：B | absolute advantage
难度：1 Easy Bloom's：Remember
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. The number of labor hours required to produce one unit of Good X in Country A is Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：B | 1.
难度：2 Medium Bloom's：Understand
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. The number of labor hours required to produce one unit of Good Y in Country B is Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：C | 1.43.
难度：2 Medium Bloom's：Understand
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. Which of the following statements is true? Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：B | Country A has an absolute advantage in the production of Good X.
难度：2 Medium Bloom's：Understand
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. Country B has an absolute advantage in the production of Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：D | only Good Y.
难度：2 Medium Bloom's：Understand
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. If Country A transfers one labor hour from the production of Good Y to the production of Good X, total world production of Good X will ________ by ________ unit(s). Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：A | increase; one
难度：2 Medium Bloom's：Understand
Consider a two-country, two-commodity model. The table below shows the units of Good X and Good Y produced in Country A and Country B per labor hour. If Country B transfers one labor hour from the production of Good X to the production of Good Y, total world production of Good Y will ________ by ________ unit(s). Productivity Country A Country B Good X 1.00 0.50 Good Y 0.20 0.70
正确答案：A | increase; 0.7
难度：2 Medium Bloom's：Understand
Manual Preview
Why Everybody Trades: Comparative Advantage
This chapter extends the analysis of international trade to consider trade in a multiple-product economy. An economy composed of two products is useful to bring out insights about international trade. This general equilibrium approach explicitly shows the effects of resource reallocations between industries. The chapter culminates in showing the importance of comparative advantage for understanding why countries trade.
The story begins with Adam Smith and absolute advantage. (A box on mercantilism summarizes the view that Smith opposed and shows how mercantilist thinking continues today.) The analysis focuses on the productivity of labor (output per hour) in producing each of two products (wheat and cloth) in two countries (the United States and the rest of the world). Smith examined the case of absolute advantage, in which labor productivity in producing one product is higher in one country and labor productivity in producing the other product is higher in the other country. With no trade each country must produce both products to meet national demands. The discussion of the Smith case focuses on the increase in global production efficiency achieved by shifting production in each country toward the product in which it has the higher labor productivity. National demands can be met by international trade—apparently excess supplies can be exported and apparently excess demands can be met by imports. The increase in total world production is the evidence of gains from international trade.
Smith's approach does not indicate what would happen if the same country has absolute advantage in both products. Ricardo took up this case and demonstrated the principle of comparative advantage—a country will export products that it can produce at low opportunity cost and import products that it would otherwise produce at high opportunity cost. The Ricardian example is developed in more detail. The ratio of resource costs (labor hour input-output coefficients, the inverse of labor productivities) indicates the opportunity costs or relative prices of the products in each country with no trade. The difference in prices with no trade sets up the opportunity for arbitrage, with each good being exported from the initially low-price country and imported by the initially high-price country. The shift to a free trade equilibrium results in an equilibrium international price. Without information on demand, we cannot say exactly what this price will be, but we do know that it is in the range bordered by the two no-trade price ratios.
Slide Outline
NextLab Bridge