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International Economics By Robert J. Carbaugh 7th Edition

International Economics By Robert J. Carbaugh 7th Edition. Chapter 2: Foundations of modern trade theory. Foundations of trade theory. Historical development of trade theory. Mercantilism positive trade balance Absolute advantage (Adam Smith)

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International Economics By Robert J. Carbaugh 7th Edition

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  1. International EconomicsBy Robert J. Carbaugh7th Edition Chapter 2: Foundations of modern trade theory

  2. Foundations of trade theory Historical development of trade theory • Mercantilism • positive trade balance • Absolute advantage (Adam Smith) • Countries benefit from exporting what they make cheaper than anyone else • Comparative advantage (David Ricardo) • Nations can gain from specialization, even if they lack an absolute advantage Carbaugh, Chap. 2

  3. Comparative advantage Absolute & Comparative Advantage Absolute advantage: each nation is more efficient in producing one good Output per labor hour Nation WineCloth United States 5 bottles 20 yards United Kingdom 15 bottles 8 yards Comparative advantage: the US has an absolute advantage in both goods Output per labor hour Nation WineCloth United States 40 bottles 40 yards United Kingdom 20 bottles 10 yards Carbaugh, Chap. 2

  4. Comparative advantage Ricardo’s Comparative Advantage in money prices Cloth (yards) Wine (bottles) Nation LaborWage Quant. Price Quant. Price US 1 hr $20/hr 40 $0.50 40 $0.50 UK 1 hr £5/hr 10 £0.50 20 £0.25 UK 1 hr $8 10 $0.80 20 $0.40 (at $1.6 = £1) Carbaugh, Chap. 2

  5. Comparative advantage Transformation schedules • Generalizes theory to include all factors, not just labor • Shows combinations of products that can be made if all factors are used efficiently • Slope, or marginal rate of transformation, shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another) Carbaugh, Chap. 2

  6. Comparative advantage Marginal Rate of Transformation A Slope = MRT = 0.5 B Wheat C Carbaugh, Chap. 2

  7. Comparative advantage Transformation schedules: constant opportunity costs Slope = 2.0 = MRT Wheat Wheat Slope = 0.5 = MRT Carbaugh, Chap. 2

  8. Comparative advantage Supply schedules: constant opportunity costs SCanada SUS SUS Bushels of wheat per auto Autos per bushel of wheat SCanada Carbaugh, Chap. 2

  9. Comparative advantage Trading under constant opportunity costs Trading possibilities line (terms of trade 1:1) B’ Trading possibilities line (terms of trade 1:1) D’ C’ E Wheat Wheat A’ C A F B D Carbaugh, Chap. 2

  10. Comparative advantage Production gains from specialization: constant opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 40 40 120 0 80 -40 Canada 40 80 0 160 -40 80 World 80 120 120 160 40 40 Carbaugh, Chap. 2

  11. Comparative advantage Consumption gains from trade: constant opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 40 40 60 60 20 20 Canada 40 80 60 100 20 20 World 80 120 120 160 40 40 Carbaugh, Chap. 2

  12. Comparative advantage Complete specialization under constant opportunity costs SCanada SUS Aw Aa’ SUS Bushels of wheat per auto Autos per bushel of wheat SCanada Aw’ Aa Carbaugh, Chap. 2

  13. Comparative advantage Changing comparative advantage MRT = 0.67 Autos Autos MRT = 0.5 Carbaugh, Chap. 2

  14. tt’ E D Comparative advantage Trade restrictions and gains from trade tt C A Crude oil B Carbaugh, Chap. 2

  15. Increasing opportunity costs Transformation schedule under increasing costs Slope 1A = 1W A Slope 1A = 4W Wheat B Carbaugh, Chap. 2

  16. Increasing opportunity costs Supply schedule under increasing costs B Supply curve of autos Bushels of wheat per auto A Carbaugh, Chap. 2

  17. Trading possibilities line C D B tt (1A =1W) Increasing opportunity costs Trading under increasing costs: US A tUS (1A = 0.33W) Wheat Carbaugh, Chap. 2

  18. Trading possibilities line B’ C’ tt (1A =1W) D’ Increasing opportunity costs Trading under increasing costs: Canada tC (1A = 3W) Wheat A’ Carbaugh, Chap. 2

  19. Increasing opportunity costs Production gains from specialization: increasing opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 5 18 12 14 7 -4 Canada 17 6 13 13 -4 7 World 22 24 25 26 3 3 Carbaugh, Chap. 2

  20. Increasing opportunity costs Consumption gains from trade: increasing opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 5 18 5 21 0 3 Canada 17 6 20 6 3 0 World 22 24 25 27 3 3 Carbaugh, Chap. 2

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