Chapter 3 Notes

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Economics for Management Studies
Garth Frazer

Chapter 3 Labour Productivity and Comparative Advantage The Ricardian Model NotesThe Concept of Comparative Advantagethe reason that international trade produces an increase in world output is that it allows each country to specialize in producing the good in which it has a comparative advantage a country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countriestrade between two countries can benefit both countries if each country exports the goods in which it has a comparative advantagein the real world international production and trade is determined in the marketplace where supply and demand ruleMisconceptions about Comparative AdvantageProductivity and Competitivenessmyth 1 free trade is beneficial only if your country is strong enough to stand up to foreign competitionit is always tempting to suppose that ability to export a good depends on your country having an absolute advantage in productivitybut an absolute productivity advantage over other countries in producing a good is neither a necessary nor a sufficient condition for having a comparative advantage in that goodcompetitive advantage of an industry depends not only on its productivity relative to the foreign industry but also on the domestic wage rate relative to the foreign wage rate in turn a countrys wage rate depends on relative productivity in its other industriesThe Pauper Labour Argumentmyth 2 foreign competition is unfair and hurts other countries when it is based on low wagesthis argument is sometimes referred to as the pauper labour argumentwhether the lower cost of a product produced in a foreign country is due to high productivity or low wages does not matterall that matters to a country is that it is cheaper in terms of its own labour for that country to produce one product over anotherExploitationmyth 3 trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nationsif a foreign country refused to let itself be exploited by refusing to trade with a country or by insisting on much higher wages in its export sector which would have the same effect real wages would be lowerAdding Transport Costs and NonTraded Goodsthere are 3 main reasons why specialization in the real international economy is not extreme1The existence of more than one factor of production reduces the tendency toward specialization2Countries sometimes protect industries from foreign competition3It is costly to transport goods and services and in s
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