Class 14
March 8
Last class:
Results of Quiz 3 and problem set 1
2. Review of economic concepts and methods
3. International trade theory
Today:
3. International trade theory
Quiz 4 (Section 2.7)
Next class:
3. International trade theory
Reading:
2. Review of economic concepts
Class 14
March 8
Important date:
Problem set 2 due Thursday, March 22
(Download the problem set from the class website)
3. International trade theory
3.1.
3.2.
3.3.
3.4.
3.5.
3.6.
3.7.
Simple examples: two-person cases
Absolute and comparative advantages
Trade between two countries
The sources of comparative advantage
Other explanations for international trade
Measurement of the gains from trade
Exchange rate and its determination
3.1. Simple examples -- two-person cases
Example 1:
Suppose Kevin and Mark have just completed the
data collection and analysis for a group project and
are ready to write the project report that will include
18 pages of text and 10 graphs. Here are the
estimated rates for both Kevin and Mark:
Text
Graphs
Kevin
2 pages/hr.
2 graphs/hr.
Mark
3 pages/hr.
1 graph/hr.
50/50 share with no specialization:
Kevin: 9 pages of text and 5 graphs ==> 7 hrs
Mark: 9 pages of text and 5 graphs ==> 8 hrs
3.1. Simple examples -- two-person cases
With specialization:
For example:
Kevin: 8 graphs & 2 pages of text ==> 5 hrs
Mark: 2 graphs & 16 pages of text ==> 7.3 hrs
OR
Kevin: 10 graphs and no text ==> 5 hrs
Mark: 18 page of text and no graph ==> 6 hrs
In this case, Kevin is more productive in graphs and
Mark is more productive in text. When each person
is more productive in one production, trade and
specialization can benefit both of them.
3.1. Simple examples -- two-person cases
Example 2:
Suppose Ashley and Helen are another group for the
same project (18 pages of text and 10 graphs) with
the following estimated rates:
Ashley
Text
2 pages/hr.
Graphs 1 graph/hr.
Helen
3 pages/hr.
2 graphs/hr.
50/50 share with no specialization:
Ashley: 9 pages of text & 5 graphs ==> 9.5 hrs
Helen: 9 pages of text & 5 graphs ==> 5.5 hrs
Helen is more productive in both text & graphs but Ashley is
less productive in both text & graphs. Can specialization
3.1. Simple examples -- two-person cases
With specialization:
Ashley: 14 pages of text & 2 graphs ==> 9 hrs
Helen: 4 pages of text & 8 graphs ==> 5.33 hrs
OR
Ashley: 18 pages of text & no graph ==> 9 hrs
Helen: 10 graphs and no text ==> 5 hrs
Ashley is less productive in both text and graphs but
is RELATIVELY more productive in preparing text
(Helen is more productive in text & graphs and
RELATIVELY more productive in graphs).
3.1. Simple examples -- two-person cases
What can we conclude from the first two examples:
(1) When each person is more productive in one
activity, specialization and trade can benefit both
of them
(2) When each person is RELATIVELY more
productive in one activity, specialization and
trade can benefit both of them.
What can we conclude from the third example
(David and John) on the next page?
3.1. Simple examples -- two-person cases
Example 3:
Text
Graphs
David
6 pages/hr.
4 graphs/hr.
John
3 pages/hr.
2 graphs/hr.
50/50 share with no specialization:
David: 9 pages of text & 5 graphs ==> 2.75 hrs
John: 9 pages of text & 5 graphs ==> 5.5 hrs
David is more productive in both text & graphs and
John is less productive in both text & graphs. Is John
RELATIVELY more productive in text or graphs?
For this example, we can not find a specialization
that can benefit both David and John.
3.2. Absolute and comparative advantages:
3.2.1. Absolute advantage:
-- One nation (person) is absolutely more
productive than the other nation (person) in
the production of one product in terms of
that it can produce the same amount of
output using less resources or it can produce
more output using the same mount of
resources.
-- Definition on page 3-3
-- The two-person examples in Section 3.1
3.2. Absolute and comparative advantages:
3.2.2. Comparative advantage
-- One nation (person) is relatively more
productive than the other nation (person) in
the production of one product when the
product can be produced at lower cost in
terms of the other goods.
-- Definition on page 3-3
-- Two-person examples in Section 3.1.
3.2. Absolute and comparative advantages:
3.2.3. Theory of comparative advantage
-- Absolute advantage is neither the
“necessary” nor “sufficient” condition for
trade
-- Comparative advantage is the “necessary”
and “sufficient” conditions for trade.
-- Two-person examples in Section 3.1
3.2. Absolute and comparative advantages:
3.2.4. David Ricardo (1772-1823):
-- A businessman, economist, policymaker, and one
of the fathers of modern economics
-- Major publication: Principles of Political
Economy and Taxation, 1817
-- Major contribution: theory of comparative
advantage
-- History:
-- In the early 19th century, British Parliament was
controlled by landlords  “Corn Laws” limit
grain imports and help exports  high price
-- Industrial Revolution  needs to reduce grain
prices
-- Corn Laws were replaced in 1848 (25 yrs after
Ricardo’s death)
3.3. Trade between two countries
3.3.1. Wheat and cotton production in Australia and
New Zealand (Table 16.2 on p. 3-4)
Wheat
Cotton
New Zealand
6 bu./acre
2 bales/acre
Australia
2 bu./acre
6 bales/acre
3.3.2. Absolute advantage
Australia: Cotton production
New Zealand: Wheat production
3.3.3. Production with no trade (Table 16.3 on p. 3-4)
-- How to interpret Figure 16.1 on p. 3-5?
-- Production possibility frontier (PPF)
3.3. Trade between two countries
3.3.4. Gains from specialization and trade (Table 16.4)
When both countries have absolute advantages,
specialization and trade can benefit both nations
A strong assumption here: 1 bushel of wheat can
be exchanged for 1 bale of cotton
How to interpret Figure 16.2 on p. 3-6?
3.3. Trade between two countries
3.3.5. Suppose the wheat and cotton productivity in
Australia and New Zealand has changed to:
Wheat
Cotton
New Zealand
6 bu./acre
6 bales/acre
Australia
1 bu./acre
3 bales/acre
3.3.6. New Zealand has the absolute advantage in
both wheat and cotton production (Australia
does not have any absolute advantage) but
Australia has the comparative advantage in
cotton production (what comparative
advantage does New Zealand have?)
3.3.7. Production with no trade (Table 16.6)