International Economics By Robert J. Carbaugh 9th Edition

1. International EconomicsBy Robert J. Carbaugh9th Edition Chapter 2: Foundations of Modern Trade Theory

2. Foundations of trade theory Historical development of trade theory • Mercantilism • Regulation to ensure a positive trade balance • Critics: possible only for short term; assumes static world economy • Absolute advantage(Adam Smith) • Countries benefit from exporting what they make cheaper than anyone else • But: nations without absolute advantage do not gain from trade • 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 10 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 Production possibilities schedule • 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 Carbaugh, Chap. 2

7. Comparative advantage Production possibilities schedules: constant opportunity costs Carbaugh, Chap. 2

8. Comparative advantage Supply schedules: constant opportunity costs Carbaugh, Chap. 2

9. Comparative advantage Trading under constant opportunity costs 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 Trade Trade (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 Carbaugh, Chap. 2

13. Comparative advantage Changing comparative advantage Carbaugh, Chap. 2

14. Comparative advantage Trade restrictions and gains from trade Carbaugh, Chap. 2

15. Increasing opportunity costs Production possibilities schedule under increasing costs Carbaugh, Chap. 2

16. Increasing opportunity costs Supply schedule under increasing costs Carbaugh, Chap. 2

17. Increasing opportunity costs Trading under increasing costs: US Carbaugh, Chap. 2

18. Increasing opportunity costs Trading under increasing costs: Canada 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 Trade Trade (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