Lecture

1. On The Theory of Comparative Advantage by NaureenSyed Lecturer in Economics DA College For Women Ph-VIII Lecture

2. Introduction of the law Definition of comparative advantage Statement of the law Assumptions Illustration ( numerical example) The case of no comparative advantage Comparative advantage with money CONTENTS

3. Given by : David Ricardo • Year : 1817 • Book: Principles of Political Economy and Taxation • This is the one of the most important and still unchallenged laws of economics • According to this law a country benefits from specializing in the production at which it is relatively most efficient. Introduction

4. “The principle that a country benefits from specializing in the production at which it is relatively most efficient.” DEFINITION OF COMPARATIVE ADVANTAGE

5. “According to the law of comparative advantage, even if one nation is less efficient than (has an absolute disadvantage with respect to) the other nation in the production of both commodities, there is still a basis for mutually beneficial trade. The first nation should specialize in the production of and export the commodity in which it its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which absolute disadvantage is greater (this is the commodity of its comparative disadvantage).” Statement

6. Fixed and identical resources Perfect factor mobility within the country Perfect factor immobility between countries Cost of production consist of labor cost only Technology is constant Constant costs of production Full employment assumptions

7. Perfect Competition Free trade Zero transportation costs Two-country, two commodity world assumptions

8. Illustration Comparative Advantage

9. United States would be indifferent to trade if it received only 4 cloths from the United Kingdom in exchange for 6 wheat. And the United States would certainly not trade if it received less than 4C for 6W. • Similarly, the United Kingdom would be indifferent to trade if it had to give up 2C for each 1W it received from the United States, and it certainly would not trade if it had to give up more than 2C for 1W. • To summarize, the United States gains to the extent that it can exchange 6W for more than 4C from the United Kingdom. The United Kingdom gains to the extent that it can give up less than 12C for 6W from the United States. Thus, the range for mutually beneficial trade is 4C < 6W <12C The gains from trade

10. The spread between 12C and 4C (i.e. 8C) represents the total gains from trade available to be shared by the two nations by trading 6W. • The closer the rate of exchange is to 4C = 6W (the domestic, or internal rate of exchange in the U.S.), the smaller is the share of the gain going to the U.S. and the larger is the share of the gain going to the U.K. • On the other hand, the closer the rate of exchange is to 6W = 12C (the domestic, or internal rate in the U.K.), the greater is the gain of the U.S. relative to that of the U.K. Total gains from traDE

11. This occurs when the absolute disadvantage that one nation has with respect to another nation is the same in both commodities. For example, if 1 hour produced 3W instead of 1W in the U.K., the U.K. would be exactly half as productive as the U.S. in the production of both wheat and cloth. The U.K.(and the U.S.) would then have a comparative advantage in neither commodity, and no mutually beneficial trade could take place. THE CASE OF NO COMPARATVE ADVANTAGE

12. Illustration The case of no comparative advantage

13. “ Even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still a basis for mutually beneficial trade, unless the absolute disadvantage ( that one nation has with respect to the other nation) is in the same proportion for the two commodities.” Modification in the law

14. According to the law of comparative advantage, even if one nation (the U.K. in this case) has an absolute disadvantage in the production of both commodities with respect to the other nation (the U.S.), there is still a basis for mutually beneficial trade. But how, you may ask, can the U.K. export anything to the U.S. if it is less efficient in the production of both commodities? The answer is that wages in the U.K. will be sufficiently lower than the wages in the U.S. so as to make the price of cloth (the commodity in which U.K. has a comparative advantage) lower in the U.K. and the price of wheat lower in the U.S. when both commodities are expressed in terms of the currency of either nation. COMPARATIVE ADVANTAGE WITH MONEY

15. Illustration Comparative Advantage with money

16. Mutually beneficial trade is possible even if one nation is less efficient than the other in the production of both commodities Conclusion

17. International Economics, Trade and Finance, 10th Edition, Dominick Salvatore. International Economics, by Appleyard and Field International Economics, 3rd Edition, James C.Ingram and Robert M. Dunn,Jr. International Economics, Theory and Policy, 7th Edition, Krugman P.A. and Obstfeld M. references

18. THANK YOU