EC120 Lecture Notes - Lecture 9: Comparative Advantage, Market Power, Opportunity Cost

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17 Jan 2018

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EC120 – Chapter 9: Application: International Trade

- A country has a comparative advantage in a good if it produces the goo at lower opportunity

cost than other countries.

• Countries can gain from trade if each exports the goods in which it has a comparative

advantage.

• Now we can apply tools of welfare economics to see where these gains come from and who

gets them.

THE WORLD PRICE AND COMPARATIVE ADVANTAGE

- Pw = the world price of a good.

• The price that prevail the world markets.

- Pd = domestic price without trade.

- If Pw > Pd: Country has a comparative advantage in good, under free trade, country exports the

good.

- If P < Pd: Coutr does’t hae a oparatie adatage, uder free trade, country imports

the good.

THE SMALL ECONOMY ASSUMPTION

- A small economy:

• It is the price taker in world markets.

• Its action have no effect on Pw.

- Canada suits the definition of a small economy.

- When small economy engages in free trade, Pw is the only relevant price:

• No seller would accept less than Pw, since she would sell the good for Pw in world markets.

• No buyer would pay more than Pw, since he would buy the good for Pw in world markets.

- Summary: Whether a good is imported or exported, trade creates winners and losers. But the

gains exceed the losses.

OTHER BENEFIT OF INTERNATIONAL TRADE

- Consumers enjoy increased variety of goods.

- Producers sell to a larger market.

• May achieve lower costs by producing on a larger scale.

- Competition from abroad may reduce market power of domestic firms.

• Which would increase total welfare

- Trade enhances the flow of ideas

• Facilitates the spread of technology around the world.

THEN WHY ALL THE OPPOSITION TO TRADE?

- Recall one of the Ten Principles from chapter 1:

• Trade can make everyone better off.

- The winners from trade could compensate the losers and still be better off.

• Yet, such compensation rarely occurs.

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Pw = the world price of a good: the price that prevail the world markets. If pw > pd: country has a comparative advantage in good, under free trade, country exports the good. If p(cid:449) < pd: cou(cid:374)tr(cid:455) does(cid:374)"t ha(cid:448)e a (cid:272)o(cid:373)parati(cid:448)e ad(cid:448)a(cid:374)tage, u(cid:374)der free trade, country imports the good. It is the price taker in world markets. Canada suits the definition of a small economy. Summary: whether a good is imported or exported, trade creates winners and losers. Producers sell to a larger market: may achieve lower costs by producing on a larger scale. Competition from abroad may reduce market power of domestic firms: which would increase total welfare. Trade enhances the flow of ideas: facilitates the spread of technology around the world. Recall one of the ten principles from chapter 1: trade can make everyone better off. Hence, the losers have more incentive to organize and lobby for restrictions on trade.

Related Questions

Suppose the market for oranges in a small country is closed to international trade. The domestic price is $3 per lb, at which 10,000 lbs are bought and sold in the country, while the world price is $4 per lb. If the country opens up to free trade with the world, the domestic quantity demanded at the world price will be 8,000 lbs, and the domestic quantity supplied at the world price will be 12,000 lbs.

A. Which of the following statements is true?

a. The country will become an importer of oranges because it has a comparative advantage in the production of oranges

b. The country will become an exporter of oranges because it has a comparative advantage in the production of oranges

c. The country will become an importer of oranges because the world has a comparative advantage in the production of oranges

d. The country will become an exporter of oranges because the world has a comparative advantage in the production of oranges

B. At what price (per lb.) will oranges be bought and sold in the country after opening up to trade?

a. $3

b. $4

c. $3.5

C. After opening up to trade, the level of exports/imports for the country will be:

a. 8,000 lbs.

b. 12,000 lbs.

c. 10,000 lbs.

d. 4,000 lbs.

D. How much (in $) is the net gain from trade for this country in opening up to free trade?

coralbadger702

Mention if the following statements are true or false. Explain clearly why, using ideas and concepts.

a. Under free trade, one country gains at the expense of the other.

b. The theory of comparative advantage states that free trade benefits all countries.

c. The Neo-classical trade theory states that trade arises due to different amounts of labor and capital in a country.

d. The H-O theory states that trade arises due to different PPFs in a country.

e. Under free trade, prices fall, so trade becomes easier.

f. A country should not have any imports and should increase exports if it wants to increase its employment levels.

g. Adam Smith recommended very strong government regulation of trade.

h. A country with higher labor productivity than another country will have a comparative advantage in the production of all goods.

i. The Theory of absolute advantage explains producer and consumer equilibriums under free trade.

j. Developed countries do not gain under free trade with developing countries.

skywasp336

Discuss and explain the difference between the two.

The principle upon which Adam Smith first claimed that free trade benefits all countries. It holds that a country benefits from trade when it produces a particular good at a lower cost (in terms of labor input) than it costs to produce the good in any other country. By specializing the in the production and export of this good and importing goods whose production costs are higher than in other countries, the country can consume more of both goods. In trade theories, this principle was later replaced by the principle of comparative advantages.

Comparative Advantage is first fully stated by David Ricardo in the early nineteenth century, this concept holds that a country has a comparative advantage in a good if it can produce that good more cheaply than it can produce other goods. By specializing in the production of goods in which it holds a comparative advantage and importing the other goods, the country can consume more of all goods. In contrast to Adam Smith, therefore, this principle states that a country need not have an absolute advantage in any good to benefit from trade. The principle provides a powerful justification for liberal international trade by asserting that all countries benefit from such trade.

skybee160

EC120 Lecture Notes - Lecture 9: Comparative Advantage, Market Power, Opportunity Cost

EC120 Full Course Notes

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