ECON 2610 Lecture Notes - Lecture 2: Bundesautobahn 60, Comparative Advantage, Exchange Rate

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Week 2 Notes
The Ricardian Trade Model
The only thing that matters is the domestic terms of trade (DTOT) must be
If a country is dominant in both, such as below, Canada will still have an
advantage in cloth (because the difference is less)
If one nation could produce absolutely larger quantities of all goods with a given amount
of labor than could another nation, free trade could still be beneficial if the degree of
relative advantage of the nation varied across goods.
A nation will be able to obtain gains from exporting a product even if the nation has an
absolute disadvantage in the production of all goods. The nation will have a comparative
advantage and will export that product in which its absolute disadvantage is least.
Canada and Mexico
2 goods, cloth and food
Canada has 800 workers
Mexico has 1300 workers
Cloth (C)
Food (F)
Mexico has an advantage in both goods
The disadvantage in cloth is less for Canada, so they have a comparative
advantage in cloth
DTOT Canada Mexico
4C = 8F 6C = 24F
1C = 2F 1C = 4F
Cloth is cheaper to produce in Mexico
As long as 1C is between 2F and 4F, then both benefit
Mexico advantage = food
Canada CA = cloth
If 1C = 3F
o Canada producing cloth, would only gain 2F domestically
Gains 3F, so +1F
o Mexico exports food, would give up 4F domestically
Only gives up 3F, so +1F
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