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Lecture 3: Comparative Advantage: An Introduction To International Economics: New Perspectives On The World Economy

The document discusses comparative advantage and how it leads to gains from international trade. It uses production possibility frontiers (PPFs) to show how Vietnam has a comparative advantage in rice production while Japan has a comparative advantage in motorcycle production. If the countries specialize according to their comparative advantages and trade, both countries can increase their consumption of both goods.

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Sara Smith
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85 views21 pages

Lecture 3: Comparative Advantage: An Introduction To International Economics: New Perspectives On The World Economy

The document discusses comparative advantage and how it leads to gains from international trade. It uses production possibility frontiers (PPFs) to show how Vietnam has a comparative advantage in rice production while Japan has a comparative advantage in motorcycle production. If the countries specialize according to their comparative advantages and trade, both countries can increase their consumption of both goods.

Uploaded by

Sara Smith
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Lecture 3: Comparative

Advantage
An Introduction to International
Economics: New Perspectives on the
World Economy

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.1: The Production Possibility


Frontier

Kenneth A. Reinert, Cambridge University


Press 2012

Review of PPF

PPFs depict the combinations of output of two


goods (rice and motorcycles) that the economy
(Vietnam or Japan) can produce given its
available resources and technology

In Figure 3.6 we have the following points:

A: full employment on the PPF


B: full employment on the PPF
C: not feasible
D: feasible with unemployed resources
Kenneth A. Reinert, Cambridge University
Press 2012

Comparative Advantage

As incomes increases in Vietnam, consumers


began to think about a motorcycle

In this lecture, we will place motorcycles


alongside rice so that you can begin to
understand

Concept of comparative advantage and its role in


generating patterns of trade among the countries of the
world
Requires the use of a production possibilities frontier

Kenneth A. Reinert, Cambridge University


Press 2012

Autarky and Comparative Advantage

Consider again Vietnam and Japan

Both of these countries produce two goodsrice


and motorcycles

Assume that demand for rice and motorcycles in


both Vietnam and Japan is such that these two
goods are consumed in the same, fixed proportions

This assumption is depicted in Figure 3.2

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.2: Demand Diagonals in


Vietnam and Japan

Kenneth A. Reinert, Cambridge University


Press 2012

Production Possibilities Frontier

Assumptions

Resource or technology conditions in Vietnam give it a


PPF that is biased towards rice
Resource or technology conditions in Japan give it a
PPF that is biased towards motorcycles

Vietnam might have superior technology in rice production,


and Japan might have superior technology in motorcycle
production or
Vietnam might be better endowed in rice production factors
(land and labor), and Japan might be better endowed in
motorcycles production factors (physical capital)

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.3: Demand and PPFs in


Vietnam and Japan

Kenneth A. Reinert, Cambridge University


Press 2012

Production Possibilities Frontier

In a system of freely operating markets and full


employment of production factors, opportunity
costs are fully reflected in relative prices

The slope of a PPF where demand diagonal crosses it is


the relative price of rice, or P P
This is shown in Figure 3.4 by drawing the tangent lines to
the PPFs at the point where the demand lines cross them,
points A
Points A in the two PPFs in Figures 3.4 represent two
countries under autarky.
R

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.4: Relative Prices in Vietnam


and Japan under Autarky

Kenneth A. Reinert, Cambridge University


Press 2012

Autarky and Comparative Advantage

The tangency line giving relative prices is flatter in Vietnam


than in Japan

The opportunity cost of rice is lower in Vietnam than in Japan


In other words, under autarky, P P P P
Or, the relative price of rice is lower in Vietnam than in Japan
V

What we have here is an expression of the pattern of


comparative advantage

Differences in economy-wide supply conditions cause differences in


relative autarky prices and hence a pattern of comparative advantage

Note that comparative advantage involves four prices rather


than two prices as in absolute advantage

Consequently, a country can have comparative advantage in a good in


which it has an absolute disadvantage
Kenneth A. Reinert, Cambridge University
Press 2012

International Trade

If Vietnam and Japan abandon autarky in favor of


trade, the world relative price of rice will lie
somewhere between the two autarky price ratios

This situation is depicted in Figure 3.5

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.5: Autarky and Comparative


Advantage in Vietnam and Japan

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.5 Discussion

These lines are steeper than the autarky price line in


Vietnam and flatter than the autarky price line in Japan

The tangencies of these world price lines with the PPFs


determine the new production points in Vietnam and
Japan

In Vietnam, the movement along the PPF from A to B involves an


increase in production of rice, while in Japan, this movement
involves an increase in production of motorcycles

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.5 Discussion (cont.)

Moving from autarky to trade restructures an economys


production towards the good in which country has a
comparative advantage

Consumption points for Vietnam and Japan must be


along our diagonal demand linesoccur where the
dashed world price lines intersect demand lines

Both consumption and production must respect world prices


both B and C must be on world price lines

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.6: Trade between Vietnam and


Japan

Kenneth A. Reinert, Cambridge University


Press 2012

Figure 3.6 Discussion

In Vietnam, production of rice exceeds consumption of rice,


and the difference is exported

Production of motorcycles, however, falls short


consumption of motorcycles, and this shortfall is imported

In Japan, production of motorcycles exceeds consumption of


motorcycles, and the difference is exported

Production of rice falls short of production, and this shortfall is


imported

A pattern of comparative advantage gives rise to a


complementary pattern of trade
Kenneth A. Reinert, Cambridge University
Press 2012

of

International Trade

Absolute advantage concept can leave the impression


that a country could lack an advantage in anything

An absolute disadvantage in a product does not preclude


having a comparative advantage in that product

Therefore have nothing to export

Vietnam could have an absolute disadvantage in rice, but still


export rice because of its comparative advantage

Comparative advantage is a more powerful concept than


absolute advantage

Perhaps the most central concept in international economics


Kenneth A. Reinert, Cambridge University
Press 2012

Gains from Trade

Should a country actually give up autarky in favor of


importing and exporting?

Figure 3.5 shows that the movement from autarky to


trade (points A to C) increases consumption of both
rice and motorcycles

Increased consumption of both goods implies that


economic welfare has increased

Vietnam and Japan have experienced gains from trade


based on comparative advantage
Kenneth A. Reinert, Cambridge University
Press 2012

Gains from Trade Caveats

Gains from trade occur for the country as a whole

Does not mean that every individual or group within the


country benefits

Good reasons to expect that there will be groups that lose from
increased trade
These groups will oppose increased trade despite the overall gains to
their country

Kenneth A. Reinert, Cambridge University


Press 2012

Appendix

Relative price determination in a PPF

Step 1: The slope of the PPF (QM/QR) is the opportunity cost of the good
on the horizontal axis, rice. It indicates how many motorcycles must be given
up to produce an additional unit of rice

Step 2: In a perfectly competitive market system when resources are fully


employed and firms maximize profits, the opportunity costs are fully reflected
in relative prices. The relative price of rice, horizontal axis, is (PM/PR)

Step 3: A tangent line to the PPF shares the same slope of the PPF,
(QM/QR)

Step 4: Given steps 1,2,3 we can see that a tangent line to the PPF has a
slope equal to the relative price of the good on the horizontal axis, (PM/PR)
Kenneth A. Reinert, Cambridge University
Press 2012

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