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ECO102H1 (54)
Chapter 26

Chapter 26

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University of Toronto St. George
Michael Ho

Chapter 33: the gains from international trade 33.1 the gain from trade  open economy: an economy that engages in international trade.  Closed economy: an economy that has no foreign trade. Also called one of autarky Interpersonal, interregional and international trade  Trade among individual allows people to specialize in activities they can do well and to buy from others the goods and services they cannot easily produce.  With trade, everyone must be self-sufficient; with trade, people can specialize in what they do well and satisfy other needs by trading.  With trade, each individuals, region, or country is able to concentrate on pruding good and services that it produces efficiently while trading to obtain goods and services that it does not produce efficiently.  Gains from trade: This basic principle is true for individuals, regions, and countries:  The gains from trade: the increased output attributes to the specialization according to comparative advantages that is made possible by trade. Illustrating the gains from trade  Absolute advantages: the situation that exists when one country can produce some commodity at lower absolute cost than another country.  The absolute cost is the dollar cost of the labour, capital, and other resources required to produce the goods. Thus, the country that can produce a specific good with fewer resources can produce it at a lower absolute cost. In the table 33-1 Canada has the absolute advantages of producing wheat and cloth over EU  Comparative advantages: the situation that exists when a country can produce a good with less forgone output of other goods than can another country.  One country has a comparative advantage in the production of a specific product if, relative to another country, its opportunity cost for producing the product is lower. Canada has a comparative advantage of producing wheat over EU because it only needs to forgone 0.2 m of cloth to make one Kg of wheat. But EU has a comparative advantage of producing cloth when it only has to forgone 2 kg of wheat to produce one meter of cloth.  Even though a country may have an absolute advantage in all goods, it cannot have a comparative advantage in all goods. And even though a country may be inefficient in absolute term and thus have no absolute advantages in any goods, it must have a comparative advantage in some good.  The gains from specialization and trade depend on the pattern of comparative, not absolute, advantage.  World production of all products can be increased if each country specializes in producing the goods in which it has a comparative advantage. These calculation shoes that there are gains from specialization given the OPP cost. To produce 5 more Kg of wheat, Canada must sacrifice 0.1 m of cloths. To produce 2 more meters of cloth the EU must sacrifice 4.0 kg of wheat. Making both changes increases world production of both wheat and cloth.  Specialization of production against the pattern of comparative advantages leads to a decline in total world output.  The slope of the production possibilities boundary indicates the Opp cost. The existence of opp cost acroos countries implies comparative advantages than can lead to gains from trade.  In the graph below, illustrates that how 2 countries can both gain from trade when they have different opp costs in production and those opp costs are independent of the level of production.  The conclusion about the gains from trade arising from international differenced in opp costs are summarized below: 1. Country A has a comparative advantage over country B in producing a product when the opp cost of production in country A is lower. This implies that, however, that it has a comparative disadvantage in some other product(s). 2. The opp cost of product X is the amount of output of other products that must be sacrificed in order to increase the output of X by one unit. 3. When opp cost for all products are the same in al countries, there is no comparative advantage and there is no possibility of gains from specialization and trade. 4. When opp costs differ in any two countries and both countries are producing both products, it is always possible to increase production of both products by a suitable reallocation of resources within each country. The gains from trade with variable costs  Economies of scale:  In industries with significant scale economies, small countries that do not trade will have low levels of outputs and therefore high costs. With international trade, however, small countries can produce for the large global market and thus produce at lower costs. International trade therefore allows small counties to reap the benefits of scale economies.  Learning by doing: the reduction in unit costs that often results as workers learn though repeatedly performing the same tasks it causes a downward shifts in the average cost curve. The effect of learning by doing is shown in the graph below: Sources of comparative advantages  Different factor endowments:  According to the Heckscher-Ohlin theory, countries have comparative advantage in the production of goods that use intensively the factors of production with which they are abundantly endowed.  Factor endowments. Countries have the CA in products that use their abundant resources relatively intensively.  Climate. Variation in national climates affects comp
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