14F International Trade

6 Pages
73 Views

Department
Economics
Course Code
ECO101H1
Professor
Gustavo Indart

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Description
INTERNATIONAL TRADE Gains from Trade Main sources of gains from trade: - difference in climate and natural resource endowment - reduction in cost of production through economies of scale - technological differences - different factor endowments Simplifying Assumptions - only 2 countries and 2 goods - labour is the only factor of production - constant returns to scale Absolute Advantage Model A country can produce a commodity utilizing less labour than the other country. Absolute advantage implies more efficiency. Both countries can gain by specializing in the production of the commodity in which they have an absolute advantage. Output of One Unit Domestic Terms of Trade: of Labour Canada Mexico Canada: 6W = 4C  1W = (2/3)C (specialize in wheat) Wheat 6 1 Mexico: 1W = 5C (specialize in cloth) Cloth 4 5 Suppose the international terms of trade are given by 1W = 1C  5C > 1W > (2/3)C Suppose Canada transfers 1 unit of labour from the cloth industry to the wheat industry Suppose Mexico transfers 1 unit of labour from the wheat industry to the cloth industry Transfer 1 unit of labour Change in from the cloth to wheat Consumption In the absolute advantage model, gains industry (Canada) Wheat Cloth from trade depend on international terms Change through Production +6 -4 of trade. This model however, doesn’t Change through Trade -6 +6 explain how terms of trade are Net Change 0 +2 determined. Both countries gain from specializing in the production of the Transfer 1 unit of labour Change in commodity in which they have absolute from the cloth to wheat Consumption advantage – but what if one country has industry (Mexico) Wheat Cloth absolute advantage in the production of Change through Production -1 +5 both commodities? Change through Trade +5 -5 Net Change +4 0 Comparative Advantage Model This model is the basis for trade even when a country has an absolute disadvantage in the production of both commodities. A country should be specialized in the production of the commodity in which it has the smaller absolute disadvantage. (It must import the commodity in which it has the greater absolute disadvantage.) A country therefore, must specialize in the production in which it has a comparative advantage (greater absolute advantage or smaller absolute disadvantage). Output of One Unit Domestic Terms of Trade: of Labour Canada: 6W = 4C  1W = (2/3)C (specialize in wheat) Canada M
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