1. Why Nations Trade
Chapter 18 1

2. Discussion Topics
Why trade?
Absolute advantage
Gains from trade 2

3. Concepts Affecting Trade
Absolute advantage – exists when one nation can produce goods more cheaply than another nation
Comparative advantage – ability of a nation to specialize in the production of the good for which it has lowest opportunity cost
Competitive advantage – economic competitiveness of a nation reflected in the absolute cost of a given good in a given market at a particular point in time 3
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4. Comparative Advantage
Comparative advantage : If one nation is less efficient in the production of a good than another nation, there is still a basis of gains from trade
A nation should specialize in production and export the good for which its relative (comparative) advantage is greatest
A nation should specialize in production and export the good for which it has the least relative disadvantage
A nation should import the good for which its relative (comparative) advantage is the least
A nation should import the good for which it has the greatest relative disadvantage 4
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5. Ratio
5.00
0.67
U.S. is most efficient producer of wheat while Mexico is most efficient producer of coffee
With trade
U.S.
specializes in wheat
exchange part of its surplus for coffee
Mexico
specialize in coffee
trade part of the surplus for wheat 5
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6. Mexico→ absolute disadvantage in producing both goods
Ratio
5.00
1.33
Mexico→ absolute disadvantage in producing both goods
U.S.→ relative advantage greatest in wheat (10/2 vs. 4/3)
→ U.S. has a comparative advantage in wheat
→Mexico has the least comparative disadvantage in coffee or comparative advantage in coffee 6
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7. Factors Affecting Comparative Advantage….
National differences in opportunity costs
Costs affected by availability of resources
Costs affected by production requirements for goods and services produced
Costs affected by resource combinations
Costs affected by resource mobility 7
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8. We assume both countries fully employ all resources, technology and specific amounts of labor per year 8
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9. U.S./Mexico Production Possibilities
U.S produces 100 tons of wheat and 40 tons of coffee.
Mexico produces 32 tons of wheat and 12 tons of coffee
200
U.S. (tons/year) 40
Mexico (tons/year)
175 32
150
125 24
100 75 16 50 8 25 20 40 60 80 12 24 36 48 60 9
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10. U.S./Mexico Production Possibilities
U.S. (tons/year)
200 40
Mexico (tons/year)
175 C 32
150
125
Wheat
Wheat 24
100 A 75 16 50 8 25 20 40 60 80 12 24 36 48 60
Coffee
Coffee
Through trade
U.S. specializes in wheat (pt B)
Trades 50 tons of wheat to Mexico for 45 tons of coffee
Consumes more of both goods at pt C (45 tons of coffee and 150 tons of wheat) than at pt A.
Comparing C w/ A → U.S. better of with trade
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11. Through trade U.S. (tons/year) Mexico (tons/year)50 C*
Mexico (tons/year) B
200 40
175 C A* 32
150
125
Wheat
Wheat 24
100 A 75 16 50 8 25 B* 20 40 60 80 12 24 36 48 60
Coffee
Coffee
Through trade
Mexico specializes in coffee, 60 tons, pt. B* and no wheat
Would trade 45 tons of coffee for 50 tons of wheat
Consume more of both goods (50 tons of wheat and 15 tons of coffee, pt C*) than at pt A*
Comparing C* w/ A* → Mexico better off with trade 11

12. Summary
The law of comparative advantage was contrasted with absolute advantage and competitive advantage.
Trade occurs because traders anticipate gains from trading.
Comparative advantage determines why nations trade.
The basis for trade is differing opportunity costs among nations.
Nations specialize in producing those goods in which they are most efficient and exchange these goods with other nations. 12