Comparative advantage (technology differences); 1  Charles van Marrewijk Comparative advantage (technology differences); 1 International trade based on differences in technology assumptions 2 countries; A and B 2 goods; X and Y 1 factor of production; labor L Constant returns to scale; CRS Labor mobility between sectors, not between countries Perfect competition No transport costs unit labor requirement = units of labor required to produce one unit of a final good By assumption this is independent of the number of laborers active in a sector (CRS), but may differ between the two countries. Let ax be the for good X in country A, etc unit labor requirement

Comparative advantage (technology differences); 2  Charles van Marrewijk Comparative advantage (technology differences); 2 We can make a table to summarize the state of technology good X good Y country A country B ay ax bx by = 6 = 4 = 2 = 3 To be concrete we put some actual numbers in the table Note that country B is more efficient than country A; it uses less labor to produce 1 unit of good X and it uses less labor to produce 1 unit of good Y. Why on earth would it trade with country A?

Comparative advantage (technology differences); 3  Charles van Marrewijk Comparative advantage (technology differences); 3 Recall the productivity table good X good Y country A country B ay ax bx by = 6 = 4 = 2 = 3 First we derive the production possibility frontiers Assume that country A has 600 laborers and country B has 300 Country A can produce 600/6 = 100 of X; or 600/4 = 150 of Y Country B can produce 300/2 = 150 of X; or 300/3 = 100 of Y

Comparative advantage (technology differences); 4  Charles van Marrewijk Comparative advantage (technology differences); 4 Country A can thus produce at most 100 X or 150 Y X Y If 12 Labor is moved from Y to X country A produces 3 less Y and 2 more X; independent of the initial point 150 100 Country A’s ppf is thus a straight line (because of CRS and 1 factor of production) A Similarly for country B 100 150 B Suppose that consumers in country A and in country B always want to consume at least some of both goods

Comparative advantage (technology differences); 5  Charles van Marrewijk Comparative advantage (technology differences); 5 In autarky (without trade) country A might produce and consume At point A, country B at point B Y Note that if country A wanted to change its consumption point it would have to move along its own ppf. A B If A wants to consume more X it has to give up 6/4 = 1.5 units of Y A’s opportunity cost of X is 1.5 Y X If B wants to consume more X it has to give up 2/3 = 0.66 of Y B’s opportunity cost of X is only 0.66 Y

Comparative advantage (technology differences); 6  Charles van Marrewijk Comparative advantage (technology differences); 6 The opportunity cost differences are evident from the table good X good Y country A country B ay ax bx by = 6 = 4 = 2 = 3 ax/ay = 1.5 bx/by = .66 If A wants to consume 1 more X it needs ax labor. These have to come from sector Y, where ax labor could have produced ax/ay of Y Similarly, for B the opportunity cost of X is bx/by of Y Good X is relatively expensive in country A if its opportunity cost in terms of Y are larger than in B, i.e. if ax/ay > bx/by For country B this implies that the opportunity cost of X is low relative to country A: Country B has a comparative advantage in X For country A the opportunity cost of Y in terms of X is low relative to country B: Country A has a comparative advantage in Y

Comparative advantage (technology differences); 7  Charles van Marrewijk Comparative advantage (technology differences); 7 The differences in opportunity costs give rise to gains from trade If A specializes in the production of X and B in the production of Y They may trade with each other, say at px/py = 0.90 Y Say A wants to buy 40 X It has to pay 36 Y Apr And might produce at Apr and consume at Ac Provided B is willing to demand 36 Y Ac A In exchange for 40 X That is the have to coincide trade triangles Bc Both countries gain: they consume more after trade B X Bpr