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1、Classical Theories of International Trade,International Economics,Chapter 1,Chapter 1 Classical Theories of International Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based on Comparative Advantage: David Ricardo 1.4 Comparative Advantage and Opportunity Cost 1.
2、5 Comparative Advantage with More Than Two Commodities and Countries 1.6 Theory of Reciprocal Demand 1.7 Offer Curve and Terms of Trade,1.1 Mercantilism,The mercantilists advocated government regulation of trade to promote a favorable trade balance. If a country could achieve a favorable trade balan
3、ce, it would receive payments from the rest of the world in the form of gold and silver. Such revenues would contribute to an increase in spending and thus a rise in domestic output and employment. Critics Possible only for short term Assuming static world economy,Chapter 1 Classical Theories of Int
4、ernational Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based on Comparative Advantage: David Ricardo 1.4 Comparative Advantage and Opportunity Cost 1.5 Comparative Advantage with More Than Two Commodities and Countries 1.6 Theory of Reciprocal Demand 1.7 Offer
5、Curve and Terms of Trade,1.2 Trade Based on Absolute Advantage: Adam Smith,With free trade, countries could concentrate their production on the goods they could produce most cheaply and enjoy all the consequent benefits from the labor division. Cost differences govern the international movement of g
6、oods. The concept of cost is founded upon the labor theory of value.,Two assumptions, within each country: Labor is the only factor of production and is homogeneous (i.e. of one quality). The cost or price of a good depends exclusively upon the amount of labor required to produce it.,1.2 Trade Based
7、 on Absolute Advantage: Adam Smith,An arithmetic example,The U.S. has an absolute advantage in iPad production; its iPad workers productivity (output per worker hour) is higher than that of the U.K, which leads to lower costs (less labor required to produce a set of iPad). In like manner, the U.K ha
8、s an absolute advantage in cloth production.,1.2 Trade Based on Absolute Advantage: Adam Smith,A Case of Absolute Advantage,Chapter 1 Classical Theories of International Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based on Comparative Advantage: David Ricardo 1
9、.4 Comparative Advantage and Opportunity Cost 1.5 Comparative Advantage with More Than Two Commodities and Countries 1.6 Theory of Reciprocal Demand 1.7 Offer Curve and Terms of Trade,1.3 Trade Based on Comparative Advantage: David Ricardo,Mutually beneficial trade can occur even when one country is
10、 absolutely more efficient in the production of all goods. The more efficient country should specialize in and export that good in which it is relatively more efficient (where its absolute advantage is bigger). The less efficient country should specialize in and export the good in which it is relati
11、vely less inefficient (where its absolute disadvantage is smaller).,Assumptions of a simplified model There are only two countries with a fixed level of technology in the world; Each country owns only one input labor, which is fixed endowed and homogenous and can move across industries but cannot fl
12、ow across countries; Each country produces two commodities; Perfect competition and free trade prevail in markets.,1.3 Trade Based on Comparative Advantage: David Ricardo,An Example of Comparative Advantage,The U.S. labor has a 5-to-1 absolute advantage in the production of iPads. The U.S. labor als
13、o has a 3-to-1 absolute advantage in the production of cloth. The U.S. has a greater absolute advantage in producing iPads than in producing cloth. China has an absolute disadvantage in the production of iPads and cloth. However, Chinas absolute disadvantage is smaller in producing cloth than in pro
14、ducing iPads.,1.3 Trade Based on Comparative Advantage: David Ricardo,A Case of Comparative Advantage,Gains from Specialization and Trade with Comparative Advantage,As the U.S. transfers 1 worker from cloth production to iPad production, its output of iPads increases by 5 and cloth production falls
15、by 15 yards. As China transfers 3 workers from iPad production to cloth production, its cloth production increases by 15 yards and iPad production falls by 3. The gain from production and trade is the increase in the world output that results from each country specializing in its production accordin
16、g to its comparative advantage.,1.3 Trade Based on Comparative Advantage: David Ricardo,The Change in the World Output Resulting from Specialization,Comparative Advantage in Money Terms,At this wage rate, Chinas average cost in dollars of producing cloth is less than the U.S. average cost. With perf
17、ectly competitive markets, Chinas selling price of cloth is lower than its U.S. selling price, and China exports cloth to the U.S Even though China is not as efficient as the U.S. in the production of cloth, its lower wage rate in terms of dollars more than compensates for its inefficiency.,1.3 Trad
18、e Based on Comparative Advantage: David Ricardo,Comparative Advantage in Money Prices,Chapter 1 Classical Theories of International Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based on Comparative Advantage: David Ricardo 1.4 Comparative Advantage and Opportuni
19、ty Cost 1.5 Comparative Advantage with More Than Two Commodities and Countries 1.6 Theory of Reciprocal Demand 1.7 Offer Curve and Terms of Trade,1.4 Comparative Advantage and Opportunity Cost,Opportunity Cost Opportunity cost is the quantity of one good that must be given up to release enough resou
20、rces to produce one more unit of another good. The marginal rate of transformation (MRT) is the quantity of one good that it must abandon to produce each additional unit of another good.,Gains from Specialization and Trade with Opportunity Costs,Both countries are better off when they specialize and
21、 trade .,1.4 Comparative Advantage and Opportunity Cost,Production and Consumption with and without Trade Based on an exchange ratio of 1 iPad=4 yards of cloth,Production Possibilities Frontier and Constant Opportunity Costs A production possibilities frontier (PPF) shows the different combinations
22、of two goods that can be produced when all of a countrys factors of production are fully employed in their most efficient way. The slope of PPF is referred to as the marginal rate of transformation (MRT), which shows the amount of one product a country must sacrifice to get one additional unit of th
23、e other product. Without specialization and trade, the U.S. and China can produce and consume at any point along their respective production possibilities frontiers.,1.4 Comparative Advantage and Opportunity Cost,1.4 Comparative Advantage and Opportunity Cost,PPF for the U.S. and China at Full Emplo
24、yment,Points below the PPF, say, Point B or B, represent possible production combinations that can be produced but are inefficient because there would be some unemployed resources. Points above the PPF, say, Point C or C, represent production combinations that are not possible for a country to produ
25、ce with available resources and technology.,1.4 Comparative Advantage and Opportunity Cost,1.4 Comparative Advantage and Opportunity Cost,With each country specializing in the production of the good in which it has a comparative advantage, 10 more iPads and 50 more yards of cloth are produced in the
26、 world. With trade, the set of consumption points that a country can achieve is determined by the terms of trade the relative price of trading iPads for cloth, and vice versa. Both countries are better off by specializing and trade than they would be without trade.,Changes in the Gains from Speciali
27、zation and Trade,1.4 Comparative Advantage and Opportunity Cost,Production and Consumption with and without Trade Based on an exchange ratio of 1 iPad=3.5 yards of cloth,As the international exchange ratio (terms of trade) changes from 1 iPad for 4 yards of cloth to 1 iPad for 3.5 yards of cloth, th
28、e trading possibilities curve moves for each country.,Changes in the Terms of Trade for the U.S. and China,1.4 Comparative Advantage and Opportunity Cost,Distribution of the Gains from Trade Changes in a countrys terms of trade over time indicate whether a country can obtain more or less quantity of
29、 imports per unit of exports. A change in a countrys terms of trade may reflect a change in either international or domestic economic conditions. When the terms of trade change as a result of a change in domestic economic conditions, the effect on the countrys welfare is uncertain.,1.4 Comparative A
30、dvantage and Opportunity Cost,Complete Specialization Each country specializes completely in the production of the good in which it has a comparative advantage and imports the other good. Complete specialization occurs because as production expands in the industry with a comparative advantage, the d
31、omestic cost of producing the product does not rise. Constant costs are assumed to prevail over the entire range of production.,1.4 Comparative Advantage and Opportunity Cost,The firms cost curves and the products supply curves are horizontal.,Supply Curves of a Good and the PPF,1.4 Comparative Adva
32、ntage and Opportunity Cost,Trade under Increasing Opportunity Costs Increasing Costs and the PPF,The PPF and Supply Curve under Increasing Cost Conditions,1.4 Comparative Advantage and Opportunity Cost,The slope of the PPF at any point is represented graphically by the slope of a tangent to that poi
33、nt. A country has increasing opportunity costs. the tangent FG is steeper than DE. Two reasons: the factors of production used to produce the products are specialized in the production of a particular product. the premise that all resources are identical in the sense that all workers and capital hav
34、e the same productivity in the production of both commodities is unrealistic.,1.4 Comparative Advantage and Opportunity Cost,Production and Consumption without Specialization and Trade Without specialization and trade, the U.S. and China can produce and consume at any point on their PPF. Production
35、and Consumption with Specialization and Trade,Specialization and Trade under Increasing Cost Conditions,1.4 Comparative Advantage and Opportunity Cost,Specializing in and exporting the good in which the country has a comparative advantage and trading for the other good enables both countries to beco
36、me better off by consuming beyond their respective PPFs. Production under increasing cost conditions constitutes a mechanism that forces prices to converge and results in neither country specializing completely in the production of the good in which it has a comparative advantage. In the case of inc
37、reasing costs, both countries continue to produce both goods after trade and it is called as partial specialization.,1.4 Comparative Advantage and Opportunity Cost,Chapter 1 Classical Theories of International Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based o
38、n Comparative Advantage: David Ricardo 1.4 Comparative Advantage and Opportunity Cost 1.5 Comparative Advantage with More Than Two Commodities and Countries 1.6 Theory of Reciprocal Demand 1.7 Offer Curve and Terms of Trade,1.5 Comparative Advantage with More Than Two Commodities and Countries,Compa
39、rative Advantage with More Than 2 Commodities Each country will then have a comparative advantage in the commodities that it exports at the particular equilibrium exchange rate established .,Commodity Prices in the U.S. and U.K.,1.5 Comparative Advantage with More Than Two Commodities and Countries,
40、If the exchange rate is 1=$2, the dollar prices of the commodities in the U.K. would be:,The U.S. will export Commodities A and B to the U.K. and import Commodities D and E from the U.K., leaving Commodity C not traded.,1.5 Comparative Advantage with More Than Two Commodities and Countries,If the ex
41、change rate becomes 1=$3. The dollar prices of the commodities in the U.K. would be:,The U.S. will export Commodities A, B and C to the U.K. and import Commodities D and E from the U.K.,1.5 Comparative Advantage with More Than Two Commodities and Countries,If the exchange rate turns to be 1=$1, the
42、dollar prices of the commodities in the U.K. would be:,The U.S. would export only Commodity A to the U.K. and import all other commodities, with the exception of Commodity B.,Comparative Advantage with More Than 2 Countries,Given the equilibrium PW/PC=3 with trade, Countries A and B will export whea
43、t to Countries D and E in exchange for cloth. Country C will not engage in international trade in this case because its pre-trade PW/PC equals the equilibrium PW/PC with trade. Given a trade equilibrium PW/PC=4, Countries A, B and C will export wheat to Country E in exchange for cloth, and Country D
44、 will not engage in the international trade. If the equilibrium turns to be PW/PC=2 with trade, Country A will export wheat to all the other countries except Country B, in exchange for cloth.,1.5 Comparative Advantage with More Than Two Commodities and Countries,Ranking of Countries in Terms of Inte
45、rnational PW/PC,Chapter 1 Classical Theories of International Trade,1.1 Mercantilism 1.2 Trade Based on Absolute Advantage: Adam Smith 1.3 Trade Based on Comparative Advantage: David Ricardo 1.4 Comparative Advantage and Opportunity Costs 1.5 Comparative Advantage with More Than Two Commodities and
46、Countries 1.6 Theory of Reciprocal Demand 1.7 Offer Curve and Terms of Trade,1.6 Theory of Reciprocal Demand,Theory of reciprocal demand suggests that the actual price at which trade takes place depends on the trading partners interacting demands. According to the theory of reciprocal demand, final
47、terms of trade will be closer to the domestic price ratio of the country with stronger demand for the imported good. The reciprocal demand theory contends that the equilibrium terms of trade depend on the relative strength of each countrys demand for the other countrys product.,1.6 Theory of Recipro
48、cal Demand,The stronger Canadian demand for autos relative to U.S. demand for wheat, the closer the terms of trade will be to Canadian domestic price ratio, and vice versa.,Equilibrium Terms-of-Trade Limits,1.6 Theory of Reciprocal Demand,The reciprocal demand theory best applies when both countries are of equal economic size, so that the demand of each country has a noticeable effect on the market price. If one country is significantly larger than the other, the larger cou