comparative_advantage

							INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;    Charles van Marrewijk, 2006; 1

             Comparative advantage (technology differences)
  International trade based on differences in technology assumptions
  • 2 countries; A and B
  • 2 goods; X and Y
  • 1 factor of production; labour L
  • Constant returns to scale; CRS
  • Labour mobility between sectors, not between countries
  • Perfect competition
  • No transport costs
  unit labour requirement = units of labour required to produce one
  unit of a final good By assumption this is independent of the
  number of labourers active in a sector (CRS), but may differ between
  the two countries.
  Let ax be the unit labour requirement for good X in country A, etc
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;     Charles van Marrewijk, 2006; 2

          Comparative advantage (technology differences)
  We can make a table to summarize the state of technology
                         good X            good Y
  country A                       ax    =6              ay      =4
  country B                       bx    =2              by      =3
  To be concrete we put some actual numbers in the table
  Note that country B is more efficient than country A; it uses less
  labour to produce 1 unit of good X and it uses less labour to produce
  1 unit of good Y. Why on earth would it trade with country A?
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;     Charles van Marrewijk, 2006; 3

           Comparative advantage (technology differences)
  Recall the productivity table
                              good X                 good Y
  country A                       ax    =6              ay      =4
  country B                       bx    =2              by      =3

  First we derive the production possibility frontiers
  Assume that country A has 600 laborers and country B has 300
  Country A can produce 600/6 = 100 of X;              or 600/4 = 150 of Y
  Country B can produce 300/2 = 150 of X;              or 300/3 = 100 of Y
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;    Charles van Marrewijk, 2006; 4

          Comparative advantage (technology differences)
  Country A can thus produce at most 100 X or 150 Y
          Y     If 12 Labour is moved from Y to X country A produces
                3 less Y and 2 more X; independent of the initial point
        150               Country A’s ppf is thus a straight line
                      A         (because of CRS and 1 factor of production)
          100                                     Similarly for country B



                                      B


              0                  100        150             X
  Suppose that consumers in country A and in country B always want
  to consume at least some of both goods
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;    Charles van Marrewijk, 2006; 5

           Comparative advantage (technology differences)
  In autarky (without trade) country A might produce and consume
           Y                 At point A, country B at point B
                             Note that if country A wanted to change its
                             consumption point it would have to move
                   A         along its own ppf.
                                     If A wants to consume more X it
                                     has to give up 6/4 = 1.5 units of Y
                                     A’s opportunity cost of X is 1.5 Y

                                      B


            0                                        X
  If B wants to consume more X it has to give up 2/3 = 0.66 of Y
  B’s opportunity cost of X is only 0.66 Y
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;     Charles van Marrewijk, 2006; 6

          Comparative advantage (technology differences)
  The opportunity cost differences are evident from the table
                              good X                 good Y
  country A                       ax    =6              ay      =4        ax/ay = 1.5
  country B                       bx    =2              by      =3        bx/by = .66
  If A wants to consume 1 more X it needs ax labour. These have to
  come from sector Y, where ax labour could have produced ax/ay of Y
  Similarly, for B the opportunity cost of X is bx/by of Y
  Good X is relatively expensive in country A if its opportunity cost in
  terms of Y are larger than in B, i.e. if ax/ay > bx/by
  For country B this implies that the opportunity cost of X is low
  relative to country A: Country B has a comparative advantage in X
  For country A the opportunity cost of Y in terms of X is low relative
  to country B:         Country A has a comparative advantage in Y
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;    Charles van Marrewijk, 2006; 7

            Comparative advantage (technology differences)
  The differences in opportunity costs give rise to gains from trade
  If A specializes in the production of X and B in the production of Y
                   They may trade with each other, say at px/py = 0.90
        Y
                   Say A wants to buy 40 X      It has to pay 36 Y
        Apr                 And might produce at Apr and consume at Ac
                                   Provided B is willing to demand 36 Y
                    Ac
              A                    In exchange for 40 X
                                            That is the trade triangles
                                            have to coincide
                              Bc
                                              Both countries gain: they
                             B                consume more after trade
          0                              Bpr                X