ECON 223 Lecture Notes - Lecture 9: Absolute Advantage, Demand Curve, Protectionism
19 Feb 2019
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Misconception about Comparative Advantage
•Free trade is beneficial only if a country is more productive than foreign countries, “only if strong enough to stand up
foreign competition”. — This statement is based on absolute advantage.
-But even an unproductive country benefits from free trade by avoiding the high costs for goods that t would
otherwise have to produce domestically.
-High costs derive from inefficient use of resources. You are not using your resources efficiently if you are not
trading.
-The benefits of free trade do not depend on absolute advantage, rather they depend on comparative advantage:
specializing in industries that use resources most efficiently. If countries focus on producing some particular
goods they will raise their possible combinations.
•Free trade with countries that pay low wages hurts high wage countries (“foreign competitions is unfair and hurts
other countries when it is based on low wages”): pauper labor argument.
-While trade may reduce wages for some workers, thereby affecting the distribution of income within a country,
trade benefits consumers and other workers.
-Consumers benefit because they can purchase goods more cheaply. Affecting lower wage workers indirectly with
higher purchasing power.
-Producers/workers benefit by earning a higher income in the industries that use resources more efficiently,
allowing them to earn higher prices and wages. Demand rises, price rises, wage rises.
•Free trade exploit less productive countries whose workers make low wages.
-While labor standards in some countries are less than exemplary compared to Western standards, they are so with
to without trade.
-are high wages and safe labor practices alternatives to trade? Deeper poverty and exploitation may result without
export production (purchasing power of a worker’s hourly wage in foreign would fall from 1/3 to 1/6 pound of
cheese).
-Consumers benefit from free trade by having access to cheaply (efficiently) produced goods.
-Producers/workers benefit from having higher profits/wages — higher compared to the alternative.
Comparative Advantage with Many Goods
•Suppose now there are N goods produced, indexed by i = 1,2,…N
•The home country’s unit labor of requirement for goods I is aLi, and corresponding foreign unit labor labor
requirement is a*Li
•Goods will be produced wherever cheaper to produce them.
•Let w represent the wage rate in the home country and w* represent the wage rate in the foreign country.
-If waL1 < w*a*L1 then only the home country will produce good 1, since total wage payments are less there. It’s
cheaper to produce there.
-Or equivalently, a*L1/aL1 (productivity at home) > w/w*, if the relative productivity of a country in producing a
good is higher than the relative wage, then the good will be produced in that country.
•If w/w* = 3, the home country will produce apples, bananas, caviar, while the foreign country will produce dates and
enchiladas.
-The relative productivities of the home country in producing apples, bananas, and caviar are higher than relative
wage.
•If each country specializes in goods that use resources productively and trades the products for those that it wants to
consume, then each benefits.
-If a country tries to produce all goods for itself, resources are “wasted”.
•The home country has high productivity in apples, bananas, and caviar that give it a cost advantage, despite its high
wage.
•The foreign country has low wages that give it a cost advantage, despite its low productivity in date production.
•Relative wage is determined by the relative supply of and relative (derived) demand for labor services.
•The relative (derived) demand for home labor services fall when w/w* rises, As domestic labor services become more
expensive relative to foreign labor services,
-Goods produced in the home country become more expensive, and demand for these goods and the labor services
to produce them falls.
-Fewer goods will be produced in the home country, further reducing the demand for domestic labor services.
Document Summary
Misconception about comparative advantage: free trade is beneficial only if a country is more productive than foreign countries, only if strong enough to stand up foreign competition . This statement is based on absolute advantage. But even an unproductive country benefits from free trade by avoiding the high costs for goods that t would otherwise have to produce domestically. High costs derive from inefficient use of resources. You are not using your resources efficiently if you are not trading. The benefits of free trade do not depend on absolute advantage, rather they depend on comparative advantage: specializing in industries that use resources most efficiently. While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers. Consumers benefit because they can purchase goods more cheaply. Affecting lower wage workers indirectly with higher purchasing power.
