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Transcript of nota model HO
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Copyright © 2010 Pearson Addison-Wesley. All rights reserved.
Chapter 3
The Classical Model
of International Trade
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Topics to be Covered
• Mercantilism
• Classical Trade Model Assumptions
•Smith’s Absolute Advantage
• Ricardo’s Comparative Advantage
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Recall: Seven Assumptions
1. Rational behavior
2. Only 2 countries & 2 goods
3. No money illusion
4. Factor endowments are fixed and technology isconstant
5. Perfect competition
6. Factor of production are perfectly mobile
7.Community preferences in consumption can be
represented by consistent set of CIC
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Mercantilism
• A system of government institutions and
policies designed to restrict international trade
•The source of a country’s wealth is gold ormoney.
• Two means of increasing a country’s wealth are
colonialism and international trade.
• A country must export more and import less.
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Adam Smith
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Adam Smith
• Attacked the mercantilist system
• Advocated free international trade
• Emphasized advantages of specialization andinternational division of labor whereby
nations specialize in the production of only a
few goods
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Additional Assumptions
• Assumption 8—Resources cannot move
between countries.
•
Assumption 9—There are no trade barriers.• Assumption 10—Exports must pay for
imports.
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Assumptions of the Classical Model
• Assumption 11—Labor is the only relevant
resource.
– Labor Theory of Value states that the pre-trade
price of a good is determined by the amount of
labor it took to produce it.
• Assumption 12—Constant returns to scale
between labor and output prevails.
– Constant returns implies a fixed ratio between the
labor used and the output level produced.
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Illustration of Absolute Advantage
• Table of labor requirements for two goods
TABLE 3.1 Absolute Advantage as a Basisfor Trade1
1Numbers in the table denote labor required to produce one unit.
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What Causes Each Country to Follow Its Absolute
Advantage?
• Market forces combined with free trade
• Given that the labor cost equals the wage
rate (W) times the amount of labor input:(refer to Table 3.1) P S W
A hours
SA W
A 3
P T W
A hours
TA W
A 6
Then,
P S / P
T in A (W
A 3 ) / (W
A 6) 3 / 6 1 / 2
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Absolute Advantage (cont.)
• In country B:
•
P S / P
T in B (W
B 1 2 ) / (W
B 4) 12 / 4 3
Since P S / P T in A < P S / P T in B, A is the lower (opportunity) cost producer
of good S and has absolute advantage in S.
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Summary of Smith’s Principle
• For various reasons such as differenttechnologies and climate, countries willproduce different goods.
•World output will increase if countriesspecialize in their absolute advantageproducts.
• This situation is the natural outcome of
market forces combined with free trade. Agood is cheapest in the country that hasabsolute advantage in its production.
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David Ricardo
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What If One Country Has Absolute Advantage in Both
Goods?
• David Ricardo’s Law of Comparative
Advantage—countries should specialize where
they have their greatest absolute advantage (if
they have absolute advantage in both goods) or
in their least absolute disadvantage (if they
have absolute advantage in neither good).
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TABLE 3.3 Comparative Advantage as
a Basis for Trade1
1Numbers in the table denote labor hours per unit of output.
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From Table 3.3
• Country A has absolute advantage in both goods S and T.
• A is 4x more efficient than B in production of good S (compare
3 hours with 12 hours).
• A is only (4/3)x more efficient than B in production of good T.
• Thus, A has comparative advantage in S.
• With trade, A will completely specialize in S.
• Do likewise for country B!
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FIGURE 3.1 Production Possibility Frontiers for Country
A and Country B
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International Terms of Trade
• Terms of Trade (TOT)—the relative price at
which trade occurs between countries.
•
The TOT will lie between the autarky prices ofthe two countries; in our example,
½ (A’s price) < TOT < 3/2 (B’s price)
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Post-trade Equilibrium
• The country with a lower autarky price of agood has comparative advantage in that good.
• With constant opportunity cost (straight-line
PPF), the country will completely specialize inits comparative advantage product once tradebegins.
• With trade, the country will now consume onthe TOT line which represents its ConsumptionPossibility Frontier.
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FIGURE 3.3 Posttrade Equilibriums for
Country A and Country B
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Trade Triangle
• Trade Triangle—a geometric device that
shows the amounts a country is willing to
trade at a particular world price.
• The trade triangle shows the desired exports
and imports of a country given the terms of
trade.
• In international trade equilibrium, the
countries’ trade triangles are congruent.
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How Can Trading Equilibrium Be
Attained?
• By reciprocal demand
• Reciprocal demand—the process of
interaction of international demand andsupply necessary to produce an equilibrium
world price.
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Summary of Ricardo’s Model
• It is not necessary for a country to possess absolute advantagein order to participate in trade. What is required iscomparative advantage in production.
• A country will specialize in and export that good in which its
has comparative advantage, i.e., has a lower pre-trade relativeprice than in the other country.
• The terms of trade or world price will settle between theautarky prices of the two countries and is determined byreciprocal demand.
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Key words
Mercantilism
Absolute advantage
Comparative advantage
Trade triangle
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Given the input-output relationships in the table below:
Countries
A BGoods
X 8 4
Y 4 1
(a) Which country has absolute advantage in which good and why?
(b) Which country has comparative advantage in which good and
why?
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Answer:
(a) B (A) has absolute advantage in both
(neither).
(b) A (B) has comparative advantage in X (Y).
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What_are_the_differences_
between_absolute_advantage_and _comparative_advantage?
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COMPARE AND CONTRAST
ABSOLUTE ADVANTAGE COMPARATIVE ADVANTAGE
SIMILARITIES
1.TWO BASIC CONCEPTS IN INTERNATIONAL
TRADE.
2. THEY ARE IN CLASSICAL MODEL.
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Absolute Advantage Comparative Advantage
1.One country can produce more
output per unit of productiveinput than another.
One country has an advantage in
every type of output that benefitfrom specializing and exporting
those product.
2. It can produce goods at lower
cost.
It can produce goods at lower
opportunity cost.
3.It is not mutually beneficial. It is mutually beneficial to
another country.
DIFFERENCES