Transcript Comparative Advantage and International Trade

Comparative Advantage and
International Trade
This presentation will take you
through description of global
trade pattern (with special
emphasis on the U.S.) and
explain the principle of
comparative advantage
An index of openness
Let
•O denote the index of openness
•X is exports
•M is imports
•GDP is gross domestic product
Thus, we have:
X M

 100
GDP
This is a
simple
measure of
the relative
importance
of the foreign
sector
Imports + Exports as a Percent of U.S. GDP, 1969-2000
28
percent
24
20
16
12
8
70
75
80
85
90
95
00
Imports and Exports of the U.S., Chained 2000 Dollars
2000
1800
1600
1400
1200
Exports
1000
Imports
800
600
400
200
Year
Source: www.bls.gov
2004
2002
2000
1999
1997
1995
1993
1992
1990
1988
1986
1985
1983
1981
1979
1978
0
U.S. Balance of Trade in Merchandise and Services
U.S. Exports by Category, 2005
4%
6%
13%
Foods, Feeds, & Beverages
26%
11%
Industrial Supplies (2)
Capital Goods
Automotive Vehicles, etc.
Consumer Goods
Other Goods
40%
Source: Bureau of Economic Analysis
U.S. Imports by Category, 2005
3% 4%
Foods, Feeds, & Beverages
25%
30%
Industrial Supplies (2)
Capital Goods
Automotive Vehicles, etc.
Consumer Goods
Other Goods
16%
22%
Source: Bureau of Economic Analysis
Top Exporting Countries, 2002
U.S.
694
Germany
612
Japan
416
France
330
China
326
U.K.
276
Canada
253
Italy
252
Netherlands
243
Belgium
213
100
200
300
400
500
600
Billions of U.S. Dollars
Source: World Trade Organization
700
800
Current Account balance of selected nations, September
2004 to September 2005
Australia
Britain
Canada
Current Account
(billions of U.S.
dollars)
-43.1
-23.5
16.3
France
Germany
Japan
Netherlands
-25.9
110.4
163.7
28.3
Sweden
U.S.
27.9
-749.7
Country
Source: The Economist
Why do countries
trade?
•Nations differ in endowments of natural, capital,
and human resources.
Example: Japan is poorly endowed in timber,
petroleum, and metal ores—but well endowed in
human and capital resources.
•International trade is (in theory, at least) based
on mutually beneficial specialization among
trading partners according to the principle of
comparative advantage.
Labor Productivity in the U.S. and Japan
Pharmaceuticals Digital Watches
United States
4 per hour
1 per hour
Japan
2 per hour
.8 per hour
•On average a U.S. worker can manufacture 4
bottles of pharmaceuticals per hour.
•On average a U.S. worker can manufacture 1
digital watch per hour.
•On average a Japanese worker can manufacture 2
bottles of pharmaceuticals per hour.
•On average a Japanese worker can manufacture
0.8 digital watches per hour.
Thus labor productivity is higher in both
activities in the U.S.
A nation is said to have a comparative
advantage in the production of a good
or service if it can produce that good or
service a lower opportunity cost than
any other nation
Opportunity cost in the U.S. and Japan
Pharmaceuticals Digital Watches
Per Bottle
Per Watch
United States
1/4 watch
4 bottles
Japan
2/5 watch
2.5 bottles
The U.S. has the comparative advantage in pharmaceuticals since
it must only sacrifice ¼ watch for every bottle in produces; whereas
Japan must sacrifice 2/5 of a watch per bottle.
Japan has the comparative advantage in watches since it must
sacrifice 2.5 bottles of pharmaceuticals per watch made; whereas
the U.S. must sacrifice 4 bottles per watch.
Costs of Production in the U.S. and Japan
Pharmaceuticals Digital Watches
United States $3.75 per bottle
$15 per watch
Japan
$5.00 per bottle $12.50 per watch
(500 yen)
(1,250 yen)
Assume that the hourly wage in the U.S. in both sectors is
$15.00. Hence the labor cost per bottle of pharmaceuticals
produced is $15.00/4 bottles = $3.75 per bottle.The labor cost per
digital watch is $15.00/1 watch = $15.00 per watch.
Assume the hourly wage in Japan (both sectors) is 1,000 yen,
then production costs in yen are given by: For pharmaceuticals:
1,000 yen/2 bottles = 500 yen per bottle; For digital watches:
1,000 yen/.8 watches = 1,250 yen per watch.
If the exchange rate is $1 = 100 yen, then Japanese
production costs in dollars convert to the numbers in
the table above
Moral of the Story
The comparison of relative
costs of production explains
why Japan exports digital
watches to the U.S. and the
U.S. exports
pharmaceuticals to Japan.