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International Political Economy Absolute Advantage Comparative Advantage.

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Presentation on theme: "International Political Economy Absolute Advantage Comparative Advantage."— Presentation transcript:

1 International Political Economy Absolute Advantage Comparative Advantage

2 International Political Economy  Why do states seek Monetary Cooperation?  Who benefits from Trade Agreements?  How do the structure of the IMF alter domestic political arrangements?  How can foreign investors “vote” in another country?

3 The “isms”: Realism  Realism (Mercantilism, Statism) Main actors are states States primarily concerned with power and/or economic security International economy conflictual, zero-sum game; insecurity of anarchy breeds competition; state concerned about relative gains of other states because of need to defend itself

4 The “isms”: Liberalism  Liberalism (including Neo- Institutionalism) Main actors are individuals/groups acting through states or other institutions Seek to maximize personal utility, generally through free markets except where inefficiencies need to be overcome International economy generally cooperative, although coordination frequently necessary.

5 The “isms”: Radicalism  Marxism Actors are classes described by different factors endowments (labor and capital) Class interests are conflictual and exploitative Capital controls the government and promotes own interests.  World Systems Theory Actors are states defined by different factor endowments (capital rich, labor rich) Class interests are conflictual and exploitative Capital controls states and international organizations and promotes own interests

6 Forms of Trade Protection  Tariffs Import Export  NTB (Non-Tariff Barriers) Quotas Regulatory Barriers Subsidies Exchange Controls

7 Theory of Absolute Advantage  “The capacity of one nation to produce more of a good with the same amount of input than another country.” Adam Smith claimed that market forces, not government controls should determine the direction, volume, and composition of international trade. Each nation should specialize in producing goods it could produce most efficiently In absolute advantage, both nations would gain from trade.  Assumptions Perfect competition and no transportation costs in a world of two countries and two products.

8 Political Economy of Trade  Absolute Advantage Adam Smith Wealth of Nations (1776) States differ in ability to produce certain goods If one state more productive in one good and the second in another should trade those goods.

9 Absolute Advantage of Free Trade Production per worker Wheat (bushels) Iron (tons) Britain USA Prices Without Trade: Price of bushel of wheat in UK = 2.5 tons of Iron Price of bushel of wheat in US =.75 tons of Iron Price of ton of iron in UK=.4 bushels of wheat Price of ton of iron in US=1.3 bushels of wheat Why Trade? For iron producers in Britain, to get 4 bushels of wheat in UK, need to give up 10 tons of iron. If trade with the US, for 10 tons of iron can buy 7.5 bushels of wheat. Could consume more wheat (or spend less iron, could purchase 4 bushels for 3 tons) For wheat producers in US, could get 3.3X more Iron for each bushel of wheat. Isn’t this bad for British wheat producers and US Iron producers? No should shift employment. Can then have more iron and more wheat. World Benefit too! Both production of wheat and iron increase by 10,000 units.

10 Theory of Comparative Advantage  “A nation having absolute disadvantages in the production of two goods compared to another nation, has a comparative advantage in producing the good in which its absolute disadvantage is less.” Theory of comparative advantage demonstrated by Ricardo in 1817.

11 Political Economy of Trade  Comparative Advantage: David Ricardo On the Principles of Political Economy and Taxation (1817) States differ in ability to produce certain goods No need for absolute advantage in productivity As long as 2 states differ in relative productivity of at least 2 goods within their economies…  It makes sense for states to specialize and trade  Comparative advantage also tells us in which good each state should specialize

12 Production per worker Wheat (bushels) Iron (tons) Britain USA Comparative Advantage Britain better than the US in everything! But relative prices still differ at domestic level. Price of bushel of wheat in UK = 4 tons of Iron Price of bushel of wheat in US = 1 tons of Iron Price of ton of iron in UK =.25 bushels of Wheat Price of ton of iron in US = 2 bushels of Wheat Why Trade? For the iron producers in the UK, to get 4 bushels of wheat in UK, need to give up 16 tons of Iron. If trade with the US, 16 tons of Iron purchase 32 bushels of wheat (or purchase 4 for 2 tons) For wheat producers in US, costs 2 bushels of wheat for 1 ton of Iron. If purchase from UK can get 8 tons of Iron for same 2 bushels (or could purchase the 1 ton for only.25 bushel). What is each country’s comparative advantage? The UK is still better off paying producing Iron and paying the US price of wheat and the US is still better off producing wheat and paying the UK price for Iron! (What about what farmers in Britain and Iron workers in US?) If the UK protects its wheat markets, what should the US do?

13 Ricardo’s comparative advantage:  Global welfare is maximized when everyone chooses free trade  Each nation’s welfare is maximized by unilateral free trade  BUT within aggregate some win and some lose No “losers” assumes perfect mobility between industries  What if some labor can’t move between wheat and iron?  Or what if comparative advantage not in industries but in factors of production (land, labor, capital) and individuals defined by ownership of these factors?  AND some countries “win” relatively more than others


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