Economic Case for Trade in Goods and Services: Principle/Theory of Comparative Advantage
Absolute Advantage
A produces X more efficiently and B produces Y more efficiently
A specializes in X and B specializes in Y
Countries should trade. Output will be greater
Principle of Comparative Advantages
Even if country A is more efficient than country B at both X and Y. Both countries will still
typically benefit from specialization and trade (overall economic output might still be higher than no
trade)
Example
2 countries
A has 100 loaves of bread or 100 bottles of wine or a combination (100 workers)
B has 30 loaves of bread or 90 bottles of wine or combinations in between (120 workers)
No currency; only barter
Country A Country B
Bread/Worker 1/1 ¼
Wine/Worker 1/1 ¾
How do we describe the comparative advantage?
A has an absolute advantage in both categories which is why absolute advantage doesn’t apply here
1/(¼) country A is 4 times more efficient than B
1/(¾) country A is 1 and ⅓ times more efficient than B
B has a comparative advantage in Wine because of the numbers/comparison and A has a comparative
advantage in Bread
IF there’s no trade, what produces the quantities of bread and wine?
World output is adding up numbers in each column
A needs to get more than 1 bottle of wine
B will only give up less than 3 bottles
A: 2 (Somewhere between 1-3, 2 is arbitrary and even numbers)
If it says A will give country B 25 loaves of bread then B must give A 50 bottles of wine
Country A: 2 bottles of wine or 1 loaf of bread
Country B: ¾ bottles of wine or ⅜ loaves of bread
Using the Rate 1 loaf = 2 bottles, we can derive the exchange rate;
Since ¾ is the number we seek at a 2:1 ratio, we then divide by ½ and get ⅜
Sources of Comparative advantage: Variations in : land, labor, natural resources, financial capital,
human capital, industry-specific competencies)
THIS IS IMPORTANT TO REVIEW. WE STRUGGLED WITH THIS RATIO
You don’t want to trade if you are both 1/1 (same slope, no trade because you can’t reach an agreed
trade amount)
Reasons rich countries trade with each other: (New trade theory)
Consumers demand variety
Country level specialization within product categories allows for economies of scale in
manufacturing
if transport costs are significant, then it needs to be included in analysis
Concentrate production in country A (when A sells more than B) if: Fixed Cost > Sales in country
B *transportation costs
1. “Why trade is good for you” (Mostly discussed in class)
a. What are the arguments for free trade?
Access to new technologies and product And competition (consumers)
b. What are the arguments against free trade?
Competition (producers), displaced workers
(This arises the question of allocative efficiency)
Forces companies to become more efficient, accelerated experience effects, increased investments in
R&D, more product variety for consumers, globalize various business activities.
Strategic trade policy
National Security Concerns
c. Does freer trade always translate to faster economic growth?
Yes trade is good
Imbalance between rich and poor country trades (protect agriculture a lot of times)
d. What are the static (i.e., one-off) gains from free trade?
The example of bread and wine
e. What are the dynamic gains from free trade?
Trade increases rate of economic growth
f. What is an optimal trade policy? When is it a better option for a country than free
g. What is a strategic trade policy? When is it a better option for a country than free trade?
Comparative advantage in an industry can be created through government
interventions
2. “Brewed force”
a. What are the sources of Belgium’s comparative advantage in beer-making?
They do not have the climate to grow grapes for wine. Romans brought brewing to belgium so
some breweries have been open as early as 1366. Belgium is located in the beer belt and has high
quality water in the area. Many different spices, fruits, and herbs are grown in Belgium.
3. “Containing the competition”
a. What competition is the port of Singapore experiencing?
b. What is the key difference between the ports of Shanghai and Singapore?
c. What is Singapore’s response to increased competition from Chinese ports?
4. “Adventures in the skin trade”
a. What are the sources of Denmark’s comparative advantage in the global fur business?
b. What were the key elements of Kopenhagen Fur’s Chinese marketing strategy, starting
5. “Rouge Alert: Climate alarm sounded over the wine industry”
a. If the climate were to change as predicted in the article, who could be the
b. How could wineries in certain parts of Europe be affected by climate change?
6. “Islamic Finance: Banking on the Ummah”
a. Why did Malaysia emerge as global the leader in Islamic finance?
b. How is a loan made by a sharia-compliant bank different from one made by a Western
trade?
in the 1990’s?
losers/beneficiaries?
bank?
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