Chapter 2: Absolute

Advantage

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

© Kenneth A. Reinert, Cambridge University

Press 2012
Absolute Advantage: Analytical
Elements
 Countries
 Sectors
 Factors of production

© Kenneth A. Reinert, Cambridge University

Press 2012
Introduction

 By using the supply and demand diagram this

chapter makes a first step in helping you to answer
these questions
 Why does a country export a particular good?
 Why does it import a particular good?
 What forces are behind the expansion of world trade
that is occurring in the world economy?
 Absolute advantage
 Possibility that, due to differences in supply conditions,
one country can produce a product at a lower price
than another country
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 2.1. A Domestic Rice Market

© Kenneth A. Reinert, Cambridge University

Press 2012
Supply and Demand in a Domestic
Market
 Throughout the world, rice is exchanged in markets
 Supply curve is upward sloping—firms supply more
rice to the market as the price increases
 Changes in price are represented in the diagram by
movements along the supply curve—changes in
quantity supplied
 Reductions in input prices and improvements in
technology shift the supply curve to the right
 Increases in input prices and technology setbacks shift
the supply curve to the left
 Known as changes in supply
© Kenneth A. Reinert, Cambridge University
Press 2012
Supply and Demand in a Domestic
Market
 Demand curve is downward sloping—consumers
demand less rice from market as price increases
 Changes in price are represented by movements
along the demand curve—changes in quantity
demanded
 Additional demand-side factors
 Incomes and preferences
 Increases shift demand curve to right
 Decreases shift demand curve to left
 Shifts are known as changes in demand

© Kenneth A. Reinert, Cambridge University

Press 2012
Supply and Demand in a Domestic
Market
 Intersection of supply and demand curves
determines the equilibrium in the domestic
rice market
 Any shifts will change equilibrium price and
quantity for rice by shifting the demand or
supply curves.
 Rice markets are international
 Cannot analyze them effectively using Figure 2.1

© Kenneth A. Reinert, Cambridge University

Press 2012
Absolute Advantage

 Rice is produced in both Vietnam and Japan

 Assume demand conditions are exactly the
same in both countries
 Implies demand curves for rice in the two countries
are exactly the same
 Trade often arises due to differences in supply
conditions
 Assume supply curve for Vietnam is farther to the right
than supply curve for Japan
 At every price Vietnam supplies more rice than Japan
 Perhaps Vietnam uses superior technology or production inputs
are lower in Vietnam
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 2.2. Demand for Rice in Vietnam
and Japan

© Kenneth A. Reinert, Cambridge University

Press 2012
Figure 2.3. Absolute Advantage in the
Rice Market

© Kenneth A. Reinert, Cambridge University

Press 2012
Autarky Price

 Since no trade is involved between Vietnam

and Japan
 These two prices are known in international
economics as autarky prices
 Autarky is a situation in which a country has no
economic relationships with other countries
 Figure 2.3 depicts a situation in which autarky price of
rice is lower in Vietnam than in Japan
 Vietnam has an absolute advantage in the production of
rice vis-à-vis Japan

© Kenneth A. Reinert, Cambridge University

Press 2012
International Trade

 Absolute advantage implies a potential

pattern of trade
 If the two countries forgo autarky and begin to
trade
 World price of rice will lie somewhere between the two
autarky prices, or
 PV < PW < PJ
 This situation is depicted in Figure 2.4

© Kenneth A. Reinert, Cambridge University

Press 2012
Figure 2.4. Trade in the Rice Market

© Kenneth A. Reinert, Cambridge University

Press 2012
Figure 2.5. A Schematic View of
Absolute Advantage

© Kenneth A. Reinert, Cambridge University

Press 2012
A Question

 What ensures that the amount exported by

Vietnam is the same as the amount imported
by Japan?
 If EV were smaller than ZJ there would be excess
demand or a shortage in world market for rice
 Excess demand causes price to rise
 As PW rose, exports of Vietnam would expand and
imports of Japan would contract until excess demand in
world market disappeared
 Similarly, if EV were larger than ZJ, PW would fall to
bring world market back into equilibrium

© Kenneth A. Reinert, Cambridge University

Press 2012
Summary So Far

 Differences in supply conditions among

countries rise to complementary patterns of
absolute advantage
 These patterns of absolute advantage make
possible complementary patterns of
international trade

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade

 Given a pattern of absolute advantage, it is

possible for a country to give up autarky in
favor of importing or exporting
 Japan can import rice, and Vietnam can export
rice
 But should a country actually do this?

© Kenneth A. Reinert, Cambridge University

Press 2012
Figure 2.6. Gains from Trade in the Rice
Market

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade in Vietnam

 When Vietnam moved from autarky to exporting in

the rice market
 Producers experience both an increase in price and an
increase in quantity supplied along the supply curve
 Should be good for producers
 Figure 2.6 shows an increase in producer surplus of area A+B as
a result of the movement from autarky to trade
 Consumers experience an increase in price and a
decrease in quantity demanded along the demand curve
 Should harm consumers
 Figure 2.6 shows a decrease in consumer surplus of area A

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade in Vietnam

 What do these effects mean for Vietnam?

 Producers have gained area A+B
 Consumers have lost area A
 Gain to producers exceeds loss to consumers
 For economy as a whole there is a net welfare increase
of area B
 Vietnam gains from its entry into world economy as an
exporter

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade in Japan

 When Japan moved from autarky to importing in

the rice market
 Producers experience a decrease in price and a
decrease in quantity supplied along the supply curve
 Should harm these producers
 You can see in Figure 2.6 that there has been a decrease in
producer surplus of area C
 Consumers experience a decrease in price and an
increase in quantity demanded
 Contribute to an increase in consumer surplus of area C + D

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade in Japan

 What do these effects mean for Japan?

 Consumers have gained C+D
 Producers have lost area C
 The gain to consumers exceeds the loss to producers
 For the economy as a whole, then, there is a net
welfare increase of area D
 Japan gains from its entry into the world economy as an
importer

© Kenneth A. Reinert, Cambridge University

Press 2012
Gains from Trade

 Moving from autarky to either importing or

exporting involves a net increase in welfare
for the country involved
 Known as gains from trade
 Many popular writings on the world economy
suggest trade relationships are a win-lose
proposition for the countries involved
 The gains from trade idea, however, tells us that
trade can be mutually beneficial to countries
involved

© Kenneth A. Reinert, Cambridge University

Press 2012
Limitations

 Trade can improve overall welfare for

the countries involved
 Concept has its limits
 Suggests the possibility that a country
could not have an absolute advantage in
anything, and would have nothing to
export at all
 This is unlikely

© Kenneth A. Reinert, Cambridge University

Press 2012
Limitations

 The notion of the gains from trade also has

its limits
 Suggests that countries as a whole mutually
gain from trade
 Does not suggest, however, that everyone
within a country will gain from trade
 Producers of rice in Japan lose from trade, and
consumers of rice in Vietnam lose from trade

© Kenneth A. Reinert, Cambridge University

Press 2012