international trade comparative and absolute advantage
TRANSCRIPT
International Trade
Comparative and Absolute Advantage
International Trade
International trade - voluntary exchange of goods and services between people of different nations
International Trade
• Trade helps a nation move beyond their Production Possibility Curve or FrontierG
unS
Butter
B
C
A F
3 Ways to Move Beyond PPF
1. Additional Resources
2. New Technology
3. International Trade
Billy bakes 10 cakes a day OR
mows 5 lawns
Brenda bakes 9 cakes a dayOR
mows 3 lawns
Absolute Advantage:
The ability to produce more of a given product with given resources than another country.
• Who has the absolute advantage in cake production?
• Who has the absolute advantage in lawn mowing production?
Billy bakes 10 cakes a day OR
mows 5 lawns
Brenda bakes 9 cakes a dayOR
mows 3 lawns
Absolute Advantage:
The ability to produce more of a given product with given resources than another country.
• Who has the absolute advantage in cake production? Billy - 10 is more than 9
• Who has the absolute advantage in lawn mowing production? Billy - 5 is more than 3
Billy bakes 10 cakes a day OR
mows 5 lawns
Brenda bakes 9 cakes a day OR
mows 3 lawns
COMPARATIVE ADVANTAGE
According to David Ricardo, whoever can make a product at the lowest opportunity cost should produce it.
To determine who has the lower opportunity cost we need to get our ratio to show for every one item produced what will be given up or what could have been produced using those resources.
Billy bakes 10 cakes a day OR
mows 5 lawns
Brenda bakes 9 cakes a dayOR
mows 3 lawns
Billy bakes 10 cakes a day
OR
mows 5 lawns
Cakes Lawns Opportunity Cost
10 5
10 ÷5 5 ÷5
2 1 To produce 1 lawn it costs 2 cakes
2÷2 1 ÷2 1 1/2 To produce 1 cake the opportunity cost is 1/2 lawn
Brenda bakes 9 cakes a day OR
mows 3 lawns
Cakes Lawns
9 3
9 ÷ 3 3 ÷ 3
3 1 To produce 1 lawn it costs
3 cakes
3÷ 3 1 ÷3
1 1/3 To produce 1 cake it costs 1/3
lawn
Who has the comparative advantage in cake production?
Who has the comparative advantage in lawn production?
Billy
Cakes Lawns
10 5
2 1
1 1/2
Brenda
Cakes Lawns
9 3
3 1
1 1/3
Who has the comparative advantage in cakeproduction? Brenda because 1/3 is less than 1/2
Who has the comparative advantage in lawn production? Billy because 2 is less than 3
Billy
Cakes Lawns
10 5
2 1
1 1/2
Brenda
Cakes Lawns
9 3
3 1
1 1/3
Terms of trade, or trading range
1 lawn mowing for 2-3 cakes
If trade takes place in this range it will be beneficial to both parties.
Billy
Cakes Lawns
10 5
2 1
1 1/2
Brenda
Cakes Lawns
9 3
3 1
1 1/3
Advantages of trade based on comparative advantage:
1. all countries benefit - obtain more goods than if they produced everything on their own
2. interdependence between countries is greater, countries no longer produce everything themselves
3. standard of living increases for all
012345678910
0 1 2 3 4 5
CAKES
LAWNS
PPF for Billy
When Billy makes 1 more cake, he gives up 1/2 lawn.
012345
678910
0 1 2 3 4 5
CAKES
LAWNS
PPF for Billy
When Billy mows 1 more lawn, he gives up 2 cakes.
0
12
3
45
6
7
89
10
0 1 2 3
CAKES
LAWNS
PPF for Brenda
When Brenda bakes 1 more cake, she gives up 1/3 lawn.
0
1
2
3
45
6
7
8
9
10
0 1 2 3
CAKES
LAWNS
PPF for Brenda
When Brenda mows 1 more lawn, she gives up 3 cakes.
International TradeIs based onComparative advantage; countries specialize in what they can produce more cheaplySpecializationleads to Economic efficiencyleads to Less Self Sufficiencyleads to Economic InterdependenceSpecialization allows more efficient use of our scarce resources.