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Chapter

ECON 208 Chapter Notes -Absolute Advantage, Comparative Advantage


Department
Economics
Course Code
ECON 208
Professor
Lee Ohanian

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Adrienne Pacini ECON 208 WEEK: November 17, 2009
THE GAINS FROM INTERNATIONAL TRADE
Chapter 33
The Gains from Trade
- Open economy: an economy that engages in international trade
- Closed economy: an economy that has no foreign trade
Interpersonal, Interregional, and International Trade
- Without trade, people must be self-sufficient
- With trade, people can specialize efficiently and satisfy other needs by trading
- This basic principle is true for individuals, regions and countries
Illustrating the Gains from Trade
- Gains from trade: the increased output due to the specialization according to comparative
advantage that is made possible by trade
- Absolute advantage: the situation that exists when one country can produce some
commodity at lower absolute cost than another country
o There can be gains from trade for both countries, despite one having absolute
advantage in production of both goods
- Comparative advantage: the situation that exists when a country can produce a good with
less forgone output of other goods than another country
o Based on opportunity costs rather than absolute costs
o The gains from specialization and trade depend on the pattern of comparative
advantage as opposed to absolute advantage
Example Scenario
- What can be produced with one unit of input?
Country
Widgets
Ayogs
1
5
10
2
100
60
o Country 1 has absolute disadvantage in production of both goods
- What is the opportunity cost of each country?
Country
Widgets
Ayogs
1
2 ayogs
0.5 widgets
2
0.6 ayogs
1.67 widgets
o Country 1 has a comparative advantage in production of ayogs
o Country 2 has a comparative advantage in production of widgets
- Each specializes in production more in its area of comparative advantage
o Country 1 shifts 10 units of resources from widgets to ayogs
o Country 2 shifts 1 unit of resources from ayogs to widgets
Country
Widgets
Ayogs
1
-50
+100
2
+100
-60
Combined
+50
+40
o So no change in resources used, but combined world output has increased for both
goods
- Trade and consumption
o Country 2 exports 70 widgets and imports 80 ayogs
o Country 1 imports 70 widgets and exports 80 ayogs
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