INTERNATIONAL ECONOMICS:

Comparative Advantage and Factor Proportions

Absolute Advantage

example
Country Philippines Vietnam Sacks of rice produced per day 20 16 Number of farmers 4 4

*Assuming that both farmers are paid equally and uses the same method of irrigation

Philippines has an absolute advantage in producing rice per day

Comparative Advantage

With no international trade:

United States

Rest of

the World

Price of cloth2.0 bushels/yard 0.67 bushel/yard Price of wheat0.5 yard/bushel 1.5 yards/bushel

Constant-Cost & Production-Possibility Curve

(billions of bushels per year) 5 0
S1

United States

S0
C

Wheat

3 0 2 0

Tr ad

eL

i ne

c pp

15

20

25 Cloth

50

(billions of yards per year)

(billions of bushels per year) 100

67
pp c

Tr a

Rest of the World

de Li ne C

Wheat
20 16

S0

76 80

100

Cloth

(billions of yards per year)

Production Possibilities under increasing costs

a. U.S. production possibility curve

b. Rising opportunity costs for producing cloth in the U.s.

(billions of bushels per year)

80 50

S1: Slope = 1 bushel/yard S0: Slope = 2bushels/yard

Wheat

Supply curve for cloth in the U.S. (= opportunity-cost curve or marginal-cost curve)

S2: Slope = 3bushels/yard 20 40 60

(billions of yards per year)

Cloth

(billions of yards per year)

Indifference curves
100
A

80
E

e ett B

Wheat

60 40 20

D
rse wo

B C

20

40

60

80

100 Yards of cloth consumed

Production & Consumption Together

(billions of bushels per year)

Indifference curves and Production Possibilities Without Trade

80

S1

50

S0 Price ratio= 2 bushels/yard

Wheat

20

40

Cloth
(billions of yards per year)

Free Trade & its effects

Indifference curves
I1 I2 United States 80 S1 50 40 T S0 C1

Production-possibility curve

I2 I1 55 C1

Rest of the World

30 15

S0

price= . 67bushel/yard

Wheat

price= 1bushel/yard

S1

20

40

60

Cloth 2 bushels/yard

60

80

100

Free Trade & its effects

Demand Curve
S US

Supply curve

PRICE OF CLOTH

PRICE OF CLOTH (bushels per yard)

2 1

A B
Cloth imports

1
0.67

Cloth exports

Sf

DUS 20 40 60
CLOTH

Df 60 80 100
CLOTH

Gains from Trade

If a country receives a higher price for its exports relative to the price that it pays for its imports.

Terms of trade

es from foreign buyers for its export products, relative to the price that the country pays foreign selle -How much is imported per export

Trade affects production & consumption

What determines Trade Pattern

Product prices differ with no trade because of the following:

Heckscher-Ohlin (H-O) Theory

A capital-abundant country will export the capital-intensive good, while the laborabundant country will export the laborintensive good. The critical assumption on the H-O model is that the two countries are identical, except for the difference in resource endowments. This also implies that the aggregate preferences are the same. The relative abundant in capital will cause the capital-abundant to produce the capitalintensive good cheaper than the laborabundance country and vice versa.