Comparative AdvantageComparative AdvantageInternational TradeElias YannopoulosNovember 26, 2012Elias Yannopoulos International TradeComparative AdvantageWhy do we trade?Easter Island example of tradeWhat happens when there is no trade?You have to produce everything you consume(Protectionism)With trade you can produce only some (or none) of what youconsumeSpecialization in production and trade (Free Trade)Remember voluntary trade helps both sidesWe trade because production cost are too high (opportunitycost)Produce if and only if: your production costs < Cost of buyingElias Yannopoulos International TradeComparative AdvantageAbsolute AdvantageFirst, Absolute Advantage - The ability to produce usingless resources than othersMicro example, Macro exampleWhen each party has an absolute advantage in a differentgood then specialization is obviously beneficialIt is still beneficial to specialize and trade even is a countryhas an absolute advantage in all goods (proof to come)In order to understand the benefits of trade we need to knowabout comparative advantageComparative Advantage - The ability to produce somethingat a lower opportunity cost than other producersElias Yannopoulos International TradeComparative AdvantageComparative AdvantageTo illustrate Comparative advantage lets look at the followingexampleSuppose there are only two nations: US and ChinaAnd there are only two goods: textiles and foodAssume for illustration that the US has an absolute advantagein the production of both goodsExample: On boardRemember trade is positive sumEven though the US has an absolute advantage in bothgoods, world output increases with specialization and tradeElias Yannopoulos International TradeComparative AdvantageGains From TradeNations can gain through trade by specializing in theproduction of goods for which they have the lowestopportunity cost and trade for other goods they want toconsumeThis doesn’t just apply to nations but to individuals as wellEx: Doctors and nursesGains from tradeNations can exploit their comparative advantageSpecialization can lead to greater efficiencyLarge scale production can lower costsLarger production can lead to greater competitionElias Yannopoulos International TradeComparative AdvantageBarriers to TradeNatural Barriers - Geography and LanguageUnnatural Barriers - tariffs and quotasTariffs - a tax on importsQuotas - a limit on the quantity of a good importedWhy do we set trade barriers?Infant industriesAnti-DumpingNational DefenseSpecial interestsElias Yannopoulos International
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