Transcript National Comparative Advantage Why do nations trade?

National
Comparative
Advantage
Why do nations trade?
1. The distributions of national resources
among nations are uneven. Every nation
has its own particular resources and skills.
2. Efficient production of various goods
requires different technologies or resources
(you can’t make computers efficiently in deep
jungles of the Congo).
3. People from time to time prefer certain
imported goods to similar domestic goods
(which would you rather drive a Toyota Lexus
or a Ford Pinto hatchback?)
Comparative Advantage
Important to trade is the need for comparative
advantages. No nation will trade if there is
nothing to gain from trade. And nations can
not trade if they do not have a comparative
advantage over their neighbors.
Suppose there were only two economies in
the world (U.S. and Brazil). Each nation
produces both wheat and coffee, but at
different levels of efficiency.
Suppose both economies have straight line
PPF’s (there is a constant cost between wheat
and coffee), thus there is no increasing
opportunity cost.
However, there are different comparative costratios that reflect differing levels of
technological progress (U.S. can product
more of each product than Brazil).
And each country chooses a mixture of
products that will provide the greatest total
utility or satisfaction.
The U.S. cost-ratio for the two products is 1 ton of
coffee for 1 ton of wheat. 1C = 1W
Coffee (tons)
30
25
20
15
A
The optimal mix
in the U.S.
economy is a
combination of 18
tons of wheat and
12 tons of coffee.
10
05
0
05
10
15
20
Wheat (tons)
25
30
The Brazilian domestic opportunity cost or cost ratio for
the two products is 2 ton of coffee for 1 ton of wheat.
2C = 1W
The optimal mix
in Brazil is 8 tons
of wheat and 4
tons of coffee.
Coffee (tons)
30
25
20
15
10
B
05
0
05
10
15
20
Wheat (tons)
25
30
If both economies produce for themselves,
the world supply of wheat would be 26 tons
and the world supply of coffee would be 16
tons.
20
Coffee
Coffee
30
12
o
18
Wheat
30
4
0
8 10
Wheat
Comparative Advantage
However, total output will be greatest when goods
are produced by the nation that has the lowest
domestic opportunity cost.
The U.S. cost for producing
1 ton of wheat is 1 ton of
coffee. Brazil’s cost of
producing wheat is 2 tons of
coffee. Thus, the U.S.
should specialize in wheat
production.
Brazil’s cost for producing 1
ton of coffee is ½ ton of wheat.
The U.S. cost of producing
coffee is 1 ton of wheat. Thus,
Brazil should specialize in
coffee production.
By specializing completely in wheat the U.S. can
produce 30 tons of wheat and no coffee.
By specializing completely in coffee, Brazil can
produce 20 tons of coffee and no wheat.
So the world ends up with 4 more tons of wheat and
4 more tons of coffee. Everyone has more of both,
and is able to consume past the PPF curve.
20
Coffee
Coffee
30
o
Wheat
30
0
Wheat
10
Before After Amount After
Special. Special. Traded Trade
Brazil
U.S.
8W
4C
18W
12C
0W
20C
30W
0C
+10W
-15C
-10W
+15C
10W
5C
20W
15C
Gain
from
Trade
2W
1C
2W
3C
If both nations specialize each can achieve
a larger total output with the same total
input of resources. They will be using their
scare resources more efficiently.
Terms of Trade:
Both economies have a comparative advantage
in something, but each must also get a better
price, in the world market, for its product than it
can get domestically; otherwise, there is no gain
from trade.
U.S. must get better than: 1C for 1W
Brazilian must get better than: 1W for 2C
So both nations will trade if there is a trade
ratio of;
1C <1W< 2C
The exact price for 1 ton of wheat will be set by the
world market price for wheat in relation to the world
market price of coffee.
If the price of coffee is lower than the price of wheat
(due to a poor wheat harvest or higher demand for
wheat) the ratio will be closer to 1W = 2C.
If the price of coffee
2
if higher than the
price of wheat
(due to poor coffee
harvest of higher
demand for coffee)
the ratio will be
closer to 1W = 1C
0
1
Wheat