ECON 2005 Lecture Notes - Lecture 29: Factor Endowment, Comparative Advantage, Opportunity Cost
Lecture #29 Notes
International Trade
Opportunity Costs and Comparative Advantage
• We can get the opportunity costs from the slopes of the PPFs
The Economic Basis for Trade: Comparative Advantage
• Absolute Advantage – The advantage in the production of a product enjoyed by one country
over another when it uses fewer resources to produce that product than the other country
does.
• Comparative Advantage – The advantage in the production of a product enjoyed by one country
over another when that product can be produced at lower cost in terms of other goods than it
could be in the other country.
• Law of Comparative Advantage – States that the country that has the lower opportunity cost of
producing a good should specialize in the production of that good.
• Theory of Comparative Advantage – Riardo’s theor that speializatio ad free trade ill
benefit all trading partners. Real wages (what people will be with their money) will rise.
Trade (assume free trade)
• First, not that with free trade, the price of the goods must be the same in both countries.
Otherwise, one could buy a product in one country and sell it in the other for a profit.
• Second, the relative price with trade will lie between the relative prices before trade.
Terms of Trade
• The ration at which a country can trade domestic products for imported products. Or how much
of one good and be exchanged for one unit of another good.
Trade
• Moral: By specializing in a good for which there is comparative advantage and trading some, a
country can expand its possible consumption. Its PPF no longer limits consumption.
• Side Note: the above applies to economies with bowed out PPFs or increasing opportunity costs.
This leads to incomplete specialization.
Reasons for Comparative Advantage
• Differences in Resource (Factor) Endowments – different countries have different endowments
of things like minerals, land, capital, labor, climate, etc. that effect the production of goods and
therefore comparative advantage.
o Important differentiation between skilled and unskilled labor: US has a well educated
work force and therefore tends to export goods produced with skilled labor and import
goods produced with unskilled labor.
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Document Summary
Opportunity costs and comparative advantage: we can get the opportunity costs from the slopes of the ppfs. Real wages (what people will be with their money) will rise. Trade (assume free trade: first, not that with free trade, the price of the goods must be the same in both countries. Otherwise, one could buy a product in one country and sell it in the other for a profit: second, the relative price with trade will lie between the relative prices before trade. Terms of trade: the ration at which a country can trade domestic products for imported products. Or how much of one good and be exchanged for one unit of another good. Trade: moral: by specializing in a good for which there is comparative advantage and trading some, a country can expand its possible consumption. Its ppf no longer limits consumption: side note: the above applies to economies with bowed out ppfs or increasing opportunity costs.
