International Economics
M1 EI; M1 EA
University Lille 1
Claire Naiditch
claire.naiditch@univ-lille1.fr
Part 1. Standard trade models
The law of comparative advantage
Preview Comparative advantage
o  The concept of comparative advantage
n  Opportunity costs
n  Absolute and comparative advantage
o  A one-factor Ricardian model
n  Production possibilities
n  Gains from trade
n  Wages and trade
o
o
o
o
o
Misconceptions about comparative advantage
Comparative advantage with many goods
Transportation costs and non-traded goods
Empirical evidence
Sources of comparative advantage
Learning goals
o  After reading this chapter, you should be
able to:
n  Explain how the Ricardian model, the most
basic model of international trade, works and
how it illustrates the principle of
comparative advantage.
n  Demonstrate gains from trade and refute
common fallacies about international trade.
n  Describe the empirical evidence
o  that wages reflect productivity and
o  that trade patterns reflect relative productivity.
Comparative Advantage and
Trade - example
Fig A.1.: Home’s Production Possibility Frontier
A one-factor Ricardian model
Relative Prices, Wages, and Supply
o  Summary
QC = 0
QC
QC = L/aLC
PC /PW
aLC /aLW
QW = L/aLW
QW
QW = 0
Fig A.2.: Foreign’s Production Possibility Frontier
A one-factor Ricardian model
Relative supply and relative demand
o  Summary
QC
Q*C = 0
QC = 0
Q*C = 0
QC = L/aLC
Q*C
QC = L/aLC
Q*C = 0
aLC /aLW
QW = L/aLW
Q*W = L*/a*LW
QC = L/aLC
Q*C = L*/a*LC
a*LC /a*LW
QW = 0
Q*W = L*/a*LW
QW
Q*W = L*/a*LW
QW = 0
Q*W
QW = 0
Q*W = 0
PC /PW
Fig A.3.: World Relative Supply and Demand
Fig A.4.: Trade Expands Consumption Possibilities
A one-factor Ricardian model
A Numerical Example
Unit Labor Requirements
for Home and Foreign countries
Cheese
Wine
Home
aLC = 1 hour/lb
aLW = 2 hours/gallon
Foreign
a*LC = 6 hours/lb
a*LW = 3 hours/gallon
o  What is the home country’s opportunity cost
of producing cheese?
n  aLC /aLW = 1⁄2
n  To produce one pound of cheese, stop producing
1⁄2 gallon of wine.
Fig A.5.: Productivity and Wage
Comparative Advantage with
Many Goods
Home and Foreign Unit Labor Requirements
Good
Home Unit
Labor
Requirement aLi
Foreign Unit
Labor
Requirement
a*Li
Relative Home
Productivity
Advantage
a*Li/aLi
Apples
1
10
10
Bananas
5
40
8
Caviar
3
12
4
Dates
6
12
2
Enchiladas
12
9
0.75
Fig A.6.: Productivity and Wage
Fig A.7.: Productivity and Exports
Empirical Evidence
Bangladesh versus China, 2011
Bangladeshi output per
worker as % of China
Bangladeshi exports as
% of China
All industries
28.5
1.0
Apparel
77
15.5
Source: McKinsey and Company, “Bangladesh’s ready-made garments industry: The
challenge of growth,” 2012; UN Monthly Bulletin of Statistics.
Sources of comparative
advantage
o  What determines comparative advantage?
n
n
n
The quantity and quality of factors of production available
o
o
Ex: good quality farmland, oil and gas, fossil fuels
Climate and geography
o
Ex: abundant low-cost labor suitable for volume production of
manufacturing products
Different proportions of factors of production (HOS)
Increasing returns to scale and the division of labor (New trade
models)
o
o
o
n
Increasing returns occur when output grows more than proportionate
to inputs.
Rising demand in the markets where trade takes place helps to
encourage specialization, higher productivity and internal and external
economies of scale.
These long-run scale economies give regions and countries a significant
advantage.
Technology
o
o
Investment in research & development
which can drive innovation and invention
Sources of comparative
advantage
o
What determines comparative advantage?
n
Fluctuations in the exchange rate,
o
n
Import controls such as tariffs, export subsidies and quotas
o
n
o
covering factors such as the standard of product design and innovation, product
reliability, quality of after-sales support.
Many countries are now building comparative advantage in high-knowledge
industries and specializing in specific knowledge sectors – an example here is the
division of knowledge in the medical industry, some countries specialize in heart
surgery, others in pharmaceuticals.
Formal institutions
o
o
o
o
n
n
These can be used to create an artificial comparative advantage for a country's
domestic producers
The non-price competitiveness of producers
o
n
which then affect the relative prices of exports and imports and cause changes in
demand from domestic and overseas customers
Political institutions and the stability of democracy (influence capital flows)
Contract enforcement
Financial development
Labor market
Informal institutions
…
Summary
1.  Differences in the productivity of labor
across countries generate comparative
advantage.
n  Institutions may affect these differences
2.  A country has a comparative advantage
in producing a good when its
opportunity cost of producing that good
is lower than in other countries.
Summary
3.  Countries export goods in which they
have a comparative advantage - high
productivity or low wages give
countries a cost advantage.
4.  With trade, the relative price settles in
between what the relative prices were
in each country before trade.
Summary
5.  Trade benefits all countries due to the
relative price of the exported good rising:
income for workers who produce exports
rises, and imported goods become less
expensive.
6.  Empirical evidence supports trade based
on comparative advantage, although
transportation costs and other factors
prevent complete specialization in
production.