Theory of Theory of comparative advantage David Ricardo
Assumptions Two countries only: Two goods only: No transportation costs Country A and Country B and Cars Wine
Before specialisation and trade : output produced per unit of resources
Which country can produce more cars with the same amount of resources? Country A Which country can produce more wine with the same amount of resources? Also Country A
Since the Country A is more productive in the production of both goods, it is said to possess an _________________ in the production of both goods. absolute advantage
Suppose: Each country has 2 units of resources What are the production combinations of the two countries before trade?
Production combinations before trade Total and 2522
= 0.6 unit of wine = 1.6 units of cars Opportunity cost of 1 case of wine Opportunity cost of 1 unit of car Country A = 2 units of wine = 0.5 units of cars Country B Opportunity costs of production
Country A has a _____ opportunity cost of producing cars than Country B. Country B has a _____ opportunity cost of producing wine than China. lower
It means that a country can produce a good at a ____________________ than another country. lower opportunity cost What is comparative advantage?
Country A has a comparative advantage in producing _________ and the Country B has a comparative advantage in producing ______. cars wine
Suppose Country A specialises in producing cars and Country B specialises in producing wine. Output after specialisation What is the output combinations after specialisation? Suppose each country has 2 units of resources: Country A: uses 1 and a half units of resources to produce cars and half a unit of resource to produce wine ( partial specialisation ) Country B: uses all the resources to produce wine ( complete specialisation )
Suppose Country A specialises in producing cars and Country B specialises in producing wine. Output after specialisation Total and 3026 What is the output combinations after specialisation?
Principle of comparative advantage After specialisation, the output of both cars and wine are higher / lower. Principle of comparative advantage: Before specialisation After specialisation When countries specialise according to their comparative advantage( lower opportunity cost ), their _______________ will be maximised. combined output
The gains from trade Suppose the terms of trade is 1unit of Car:1 unit of wine. Volume of trade : 9 units of cars and 9 cases of wine. What is the consumption combinations after trade? Total and 3026
=(1 – 0.6) wine=( 1 -0.5)car The gains from trade Country A:1 unit of car exported Suppose the terms of trade is 1 Car: 1 Wine. Alternatively, gains from trade: =0.4 wine = 0.5 car Gain Country B:1 unit of wine exported
1. International transfer of __________ 2. Increasing ___________ in the domestic market 3. Raising the ________________ Other gains from trade technology competition standard of living
Costs of conducting trade 1. Transportation cost _______ the gains from trade. 2. Political disturbance or war _____ the risk and hence _______ the gains from trade. reduces raises reduces
If the terms of trade is 1C:1.9 W, what will be the gains from trade? For each unit of computers exported, gain for China = __________________ For each unit of computers imported, gain for the USA A = _________________ (1.9-1.11) W = 0.79 W (2- 1.9) W = 0.1 W( saved )
Is it possible for a country to have comparative advantage in all the goods it produces? ___, it’s __________. So, when Country A’s opportunity cost of producing one good is lower than that of Country B, its opportunity cost of producing another good MUST be ______ than that of the Country B. It is because the opportunity cost of producing one good is the _________ of the opportunity cost of producing the other good. impossible reciprocal higher No
‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. Absolute advantage: the country is more productive in producing a good with the _____ amount of resources than another country. It is ________ to the productivity of a country. same Comparative advantage: the country has a _____ opportunity cost of producing a good than another country. It is _________ to the productivity of a country. lower related unrelated
‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. The Country A has _________________ in the production of both goods, but it has the ____________________ in producing wheat only. absolute advantage comparative advantage e.g.