Class 15 March 20 Last class: 3. International trade theory Quiz 4 (section 2.7) Today: Result of Quiz 4 3. International trade theory Next class: 3. International trade theory Reading: 3. International trade, comparative advantage …

Class 15 March 20 Important dates: Problem set 2 due Thursday, March 22 Midterm exam (chapters 1 – 3) Thursday (March 29) or Tuesday (April 3)?

Result of Quiz 4 N = 37 Range = 2 – 10 Average = Impacts of trade as compared to no trade 2. Impacts of an import tax as compared to free trade 3. Two nations (a) A graphical analysis (b) P*, Qs, Qd, CS and PS in country B when there is no trade (c) Quantity of trade under free trade and no transportation costs

3. International trade theory 3.1. Simple examples: two-person cases 3.2. Absolute and comparative advantages 3.3. Trade between two countries 3.4. The sources of comparative advantage 3.5. Other explanations for international trade 3.6. Measurement of the gains from trade 3.7. Exchange rate and its determination

3.2. Absolute and comparative advantages: Absolute advantage: -- One nation (person) is absolutely more productive than the other nation (person) in the production of one product in terms of that it can produce the same amount of output using less resources or it can produce more output using the same mount of resources. -- Definition on page The two-person examples in Section 3.1

3.2. Absolute and comparative advantages: Comparative advantage -- One nation (person) is relatively more productive than the other nation (person) in the production of one product when the product can be produced at lower cost in terms of the other goods. -- Definition on page Two-person examples in Section 3.1.

3.2. Absolute and comparative advantages: Theory of comparative advantage -- Absolute advantage is neither the “necessary” nor “sufficient” condition for trade -- Comparative advantage is the “necessary” and “sufficient” conditions for trade. -- Two-person examples in Section 3.1

3.2. Absolute and comparative advantages: David Ricardo ( ): -- A businessman, economist, policymaker, and one of the fathers of modern economics -- Major publication: Principles of Political Economy and Taxation, Major contribution: theory of comparative advantage -- History: -- In the early 19 th century, British Parliament was controlled by landlords  “Corn Laws” limit grain imports and help exports  high price -- Industrial Revolution  needs to reduce grain prices -- Corn Laws were replaced in 1848 (25 yrs after Ricardo’s death)

3.3. Trade between two countries Wheat and cotton production in Australia and New Zealand (Table 16.2 on p. 3-4) New ZealandAustralia Wheat 6 bu./acre 2 bu./acre Cotton 2 bales/acre6 bales/acre Absolute advantage Australia: Cotton production New Zealand: Wheat production Production with no trade (Table 16.3 on p. 3-4) -- How to interpret Figure 16.1 on p. 3-5? -- Production possibility frontier (PPF)

3.3. Trade between two countries Gains from specialization and trade ( Table 16.4 ) When both countries have absolute advantages, specialization and trade can benefit both nations A strong assumption here: 1 bushel of wheat can be exchanged for 1 bale of cotton How to interpret Figure 16.2 on page 3.6?

3.3. Trade between two countries Suppose the wheat and cotton productivity in Australia and New Zealand has changed to: New ZealandAustralia Wheat 6 bu./acre 1 bu./acre Cotton 6 bales/acre3 bales/acre New Zealand has the absolute advantage in both wheat and cotton production (Australia does not have any absolute advantage) but Australia has the comparative advantage in cotton production (what comparative advantage does New Zealand have?) Production with no trade (Table 16.6)

3.3. Trade between two countries Gains from specialization and trade ( Table 16.7 ) Although Australia does not any absolute advantage, specialization and trade can benefit both nations because both nations have comparative advantages Data on production costs: Country ACountry B Wheat $3/bu.$2/bu. Cotton $6/bale$8/bale

Take-home exercise (Tuesday, March 20) Data on production costs: Country C Country D Wheat $3/bu.$2/bu. Cotton $6/bale$5/bale Which country has the absolute advantage in wheat production? Which country has the absolute advantage in cotton production? Which country has the comparative advantage in wheat production? Which country has the comparative advantage in cotton production? Can specialization and trade benefit both countries? If yes, which country is likely to export wheat?