Chapter 33 (842-855)
The Gains from International Trade
Gains from Trade:
• Form the basis for all consumption beyond subsistence level
• At the individual level if we did not specialize and trade (the division of labour)
we would each have to be economically self-sufficient
• Produce everything we consume -development of markets within economies
• Arise spontaneously due to the gains from specialization and trade
• Same logic holds at other levels -inter-regional level -international level
An Individual Level Example Autarky (no trade):
• Crusoe and Friday are each alone at opposite ends of an island.
• Crusoe can produce either 10 coconuts or 5 fish a day (or any linear combination).
C=10-2F (opportunity cost of 1 fish is 2 coconuts) therefore the slope of the PPB is 2.
• Friday can produce either 5 coconuts or 10 fish a day (or any linear combination).
C= 5 – ½ F (opportunity cost of 1 fish is a ½ coconut) the slope is therefore ½
• In autarky (with no trade) each person’s PPB is also his Consumption Possibilities
• Suppose in autarky, Crusoe chooses 2 fish and 6 coconuts, Friday chooses 8 fish
and 1 coconut
• Shown above at the point’s A-total output in autarky is 10 fish and 7 coconuts
• In autarky, we’re left inside the economy wide PPB
• Inefficiency in the allocation of resources • What if these two were brought into the same economy? Economy-wide PPB:
• It is clear that the overall autarky production is inefficient since it leaves this
“economy” operating inside its PPB.
• Voluntary trade brings the two into the same economy.
• The gains from trade allow the two to reach the economy-wide PPB.
Gains from Specialization and Trade
• -This change moves them closer to the economy wide PPB and the additional
output is a measure of the gains from trade.
• Would arise spontaneously due to the difference in opportunity costs for the two:
• Any “trade price” for fish:
Would cause Friday to produce more fish and trade for coconuts and would cause Crusoe
to produce more coconuts and trade for fish
• Both would be better off
• They are sharing the gains from trade
• In this way, trade allows for the division of labour and generates gains for the
• We can also see how non-linear PPBs come about (imagine an economy with
many people each of whom has a slightly different individual linear PPB).
Absolute and Comparative Advantage
• In our example above that Crusoe was better at producing coconuts and Friday
was better at producing fish.
• Crusoe could produce a coconut in 1/10 of a day while Friday took 1/5 of a day.
• Friday could produce a fish in 1/10 of a day; Crusoe took 1/5 of a day. • Crusoe had an absolute advantage in the production of coconuts and Friday had
an absolute advantage in the production of fish.
• Aproducer has an absolute advantage when it has a lower resource cost of
production (as above) or, equivalently higher productivity (more output per unit
• It turns out that this is not really important to the generation of the gains from
• What is important is comparative advantage – having a lower opportunity cost
• What generated the gains above was the fact that Crusoe had a lower opportunity
cost of coconuts and Friday had a lower opportunity cost of fish
• Aproducer a comparative advantage in the production of a good when it has a
lower opportunity cost of producing that good compared to another producer
• Given the reciprocal nature of opportunity cost, this implies that the other
producer has a comparative advantage in the production of the other good.
It is comparative advantage that leads to the gains from trade.
• Shown in the following international level example
International Level Example
(see also example in Tables 33-1, 33-2, and 33-3)
• Suppose that per unit of resources France can produce 4 cases of Red wine or 2
cases of White wine
• And that per unit of resources Germany can produce 1 case of Red wine or 1
case of White w