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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Introduction
Objectives / key terms
Comparative advantage
Production possibility frontier (ppf)
Autarky
Terms of trade
Gains from trade
World ppf
David Ricardo (1772-1823)
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Classical economics and comparative advantage
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.
According to Paul Samuelson (1915-; Nobel prize 1970) the theory
of comparative advantage is
One of the few ideas in economics that is true without being obvious
The idea of comparative advantage is often misunderstood, see
Paul Krugman (1953-) “Ricardo’s difficult idea”
at
http://web.mit.edu/krugman/www
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Analysis of comparative advantage
International trade based on differences in technology
• 2 countries; EU and Kenya
• 2 goods; Food and Chemicals
• 1 factor of production; labor L
assumptions
• Constant returns to scale; CRS
• Labor mobility between sectors, not between countries
• Perfect competition
• No transport costs
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 a FEU be the unit labor requirement for good F in EU, etc
International Trade & the World Economy;  Charles van Marrewijk
Analysis of comparative advantage
Productivity table to summarize the state of technology
Table 3.1 Productivity table; labor required to produce 1 unit of output
General specification
Example
Food
Chemicals
Food
Chemicals
EU
a FEU
aCEU
EU
2
8
Kenya
a FK
aCK
Kenya
4
24
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
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
+6
+2
-4
The extra production represents gains from trade
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Production possibility frontier and autarky
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
International Trade & the World Economy;  Charles van Marrewijk
Production possibility frontier and autarky
Food
100
EU ppf
B
D
30
Kenya ppf
C
E
A
0
5
25 Chemicals
Autarky prod. and cons. along ppf (determines autarky price ratio)
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Terms of trade and gains from trade
Food
120
100
EU budgetline
Terms of trade is
4.8 food per unit
of chemicals
EU ppf
B
30 F
A
Kenya ppf
0
Kenya
budgetline
5 6.25
G
25 Chemicals
Both countries gain if international price is in between autarky prices
International Trade & the World Economy;  Charles van Marrewijk
Terms of trade and gains from trade
Terms of trade is
4 food per unit of
chemicals
Food
120
100
EU ppf
B
EU budgetline
30 F
Kenya
budgetline
A
Kenya ppf
0
5
7.5
25 Chemicals
Only Kenya gains if international price is equal to EU autarky price
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Application: Kenya and the EU
Kenya export (%) - import (%)
100
food
50
0
0
50
100
150
200
chemicals
machinery
-50
Relative productivity ratio (Kenya/EU); %
Not all exports behave in accordance with comparative advantage
(but explains more trade flows than absolute advantage)
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
More countries and world ppf
Food
Food
Country B and C ppf
C
Country A and D ppf
D
B
A
Chemicals
Chemicals
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)
International Trade & the World Economy;  Charles van Marrewijk
More countries and world ppf
Food
Fmax
A
E0
B
slope   pc 0 / p f 0
slope   pc1 / p f 1
C
E1
World ppf
0
D
Chemicals
Cmax
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
The Balassa index II
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.
International Trade & the World Economy;  Charles van Marrewijk
The Balassa index II
The probability density function of the Balassaindex based on monthly-moving annual
observations (restricted to 0  BI  4)
frequency
source: Hinloopen and van Marrewijk (2001)
0.04
0.68
1.32
1.96
Balassa-index
2.60
3.24
3.88
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
Application: Kenya and the EU
More countries and world ppf
The Balassa index II
Conclusions
International Trade & the World Economy;  Charles van Marrewijk
Conclusions
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).