International Trade

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ICN Business School
International Economics Prof. Andrea Mantovani
University of Bologna
Email: a.mantovani@unibo.it Homepage: http://www.dse.unibo.it/mantovan

1. Classical Theories of International Trade: “country based theories”

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The Ricardian Model
The Ricardian model says differences in productivity of labor between countries cause productive differences, leading to gains from trade. Differences in productivity are usually explained by differences in technology.

Comparative Advantage and Opportunity Cost
A country faces opportunity costs when it employs resources to produce goods and services. For example, a limited number of workers could be employed to produce either roses or computers. The opportunity cost of producing computers is the amount of roses not produced. The opportunity cost of producing roses is the amount of computers not produced. A country faces a trade off: how many computers or roses should it produce with the limited resources that it has?

It uses the concepts of opportunity cost and comparative advantage. The opportunity cost of producing something measures the cost of not being able to produce something else.

Source: Krugman and Obstfeld (2006), International Economics, Ch. 3

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Source: Krugman and Obstfeld (2006), International Economics, Ch. 3

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Comparative Advantage and Opportunity Cost
Suppose that in the US 10 million roses can be produced with the same resources that could produce 100,000 computers. Suppose that in Ecuador 10 million roses can be produced with the same resources that could produce 30,000 computers. Workers in Ecuador are less productive than those in the US in manufacturing computers. Quick quiz: what is the opportunity cost for Ecuador if it decides to produce roses? Source: Krugman and Obstfeld (2006), International Economics, Ch. 3 5

Comparative Advantage and Opportunity Cost

A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than it is in other countries. A country with a comparative advantage in producing a good uses its resources most efficiently when it produces that good compared to producing other goods. Source: Krugman and Obstfeld (2006), International Economics, Ch. 3 6

Comparative Advantage and Opportunity Cost
The US has a comparative advantage in computer production: it uses its resources more efficiently in producing computers compared to other uses. Ecuador has a comparative advantage in rose production: it uses its resources more efficiently in producing roses compared to other uses. Suppose initially that Ecuador produces computers and the US produces roses, and that both countries want to consume computers and roses. Can both countries be made better off?

Comparative Advantage and Trade

Millions of Roses U.S. -10

Thousands of Computers +100

Ecuador

+10

-30

Total

0

+70

Source: Krugman and Obstfeld (2006), International Economics, Ch. 3

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Source: Krugman and Obstfeld (2006), International Economics, Ch. 3

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Comparative Advantage and Trade
In this simple example, we see that when countries specialize in production in which they have a comparative advantage, more goods and services can be produced and consumed. Initially both countries could only consume 10 million roses and 30 thousand computers. If they produced goods in which they had a comparative advantage, they would still consume 10 million roses, but could consume 70,000 more computers.

Trade in the Ricardian Model
Now consider wine and cheese. Suppose that the domestic country has a comparative advantage in cheese production; its opportunity cost of producing cheese is lower than it is in the foreign country. When the domestic country increases cheese production, it reduces wine production less than the foreign country does because the domestic unit labor requirement of cheese production is low compared to that of wine...
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