Theory of comparative advantage David Ricardo

1. Theory of comparative advantage David Ricardo

2. Two countries only: Country A Assumptions and Country B  Two goods only: and Cars Wine  No transportation costs

3. Before specialisation and trade : output produced per unit of resources

4. Which country can produce more cars with the same amount of resources? Country A Which country can produce more wine with the same amount of resources? Also Country A

5. Since the Country A is more productive in the production of both goods, it is said to possess an _________________ in the production of both goods. absolute advantage

6. Suppose: Each country has 2 units of resources What are the production combinations of the two countries before trade?

7. Production combinations before trade Total and 25 22

8. Opportunity costs of production Opportunity cost of 1 unit of car Opportunity cost of 1 case of wine Country A = 0.6 unit of wine = 1.6 units of cars Country B = 2 units of wine = 0.5 units of cars

9. Opportunity costs of production Country A has a _____ opportunity cost of producing cars than Country B. lower Country B has a _____ opportunity cost of producing wine than China. lower

10. What is comparative advantage? It means that a country can produce a good at a ____________________ than another country. lower opportunity cost

11. Country A has a comparative advantage in producing _________ and the Country B has a comparative advantage in producing ______. cars What is comparative advantage? wine

12. Output after specialisation Suppose Country A specialises in producing cars and Country B specialises in producing wine. What is the output combinations after specialisation? Suppose each country has 2 units of resources: Country A: uses 1 and a half units of resources to produce cars and half a unit of resource to produce wine ( partial specialisation ) Country B: uses all the resources to produce wine ( complete specialisation )

13. Output after specialisation Suppose Country A specialises in producing cars and Country B specialises in producing wine. What is the output combinations after specialisation? Total and 30 26

14. After specialisation Before specialisation Principle of comparative advantage After specialisation, the output of both cars and wine are higher / lower. Principle of comparative advantage: When countries specialise according to their comparative advantage( lower opportunity cost ), their _______________ will be maximised. combined output

15. Total and 30 26 Suppose the terms of trade is 1unit of Car:1 unit of wine. Volume of trade : 9 units of cars and 9 cases of wine. The gains from trade What is the consumption combinations after trade?

16. The gains from trade Before trade After trade

17. The gains from trade Suppose the terms of trade is 1 Car: 1 Wine. Alternatively, gains from trade: Country A:1 unit of car exported Country B:1 unit of wine exported Gain =(1 – 0.6) wine Gain =( 1 -0.5)car = 0.5 car =0.4 wine

18. Other gains from trade 1. International transfer of __________ technology 2. Increasing ___________ in the domestic market competition 3. Raising the ________________ standard of living

19. 1. Transportation cost _______ the gains from trade. reduces Costs of conducting trade 2. Political disturbance or war _____ the risk and hence _______ the gains from trade. raises reduces

20. Quiz 1 If the terms of trade is 1C:1.9 W, what will be the gains from trade? For each unit of computers exported, gain for China = __________________ (1.9-1.11) W = 0.79 W For each unit of computers imported, gain for the USA A =_________________ (2- 1.9) W = 0.1 W( saved )

21. Quiz 2 Is it possible for a country to have comparative advantage in all the goods it produces? ___, it’s __________. No impossible It is because the opportunity cost of producing one good is the _________of the opportunity cost of producing the other good. reciprocal So, when Country A’s opportunity cost of producing one good is lower than that of Country B, its opportunity cost of producing another good MUSTbe ______ than that of the Country B. higher

22. Quiz 3 ‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. Absolute advantage: the country is more productive in producing a good with the _____ amount of resources than another country. same It is ________ to the productivity of a country. related lower Comparative advantage: the country has a_____opportunity cost of producing a good than another country. It is _________ to the productivity of a country. unrelated

23. Quiz 3 ‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. e.g. The Country A has _________________ in the production of both goods, but it has the ____________________ in producing wheat only. absolute advantage comparative advantage

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