2nd year
international Economics- Part (3)-AMT
international trade: Revision on chapter (2)
◼ Law of absolute advantage
‫ ان كل دولة على االقل متفوقة فى انتاج سلعة معينة و عندها كفائة فيها يبقى تتخصص فى السلعة‬..‫و ده قال عليه ادم سميث‬
‫دى و الدولة التانية تعمل نفس الكالم و يتاجروا السلعة األقل كفاءة فيها‬
Table (1)
U.S.
U.K.
Wheat (bushels/labor hour)
6
1
Cloth (yards/labor hour)
2
4
‫لو بصينا على الجدول هنالقى فى ساعة عمل‬
..‫امريكا تنتج فيها اكتر من انجلترا فى القمح‬
‫لكن انجلترا تقدر تنتج اكترقماش فيها من‬
‫امريكا‬
then U.S has absolute advantage in wheat, U.K has absolute advantage in cloth
Law of comparative advantage
‫و ده قال عليه دايفيد ريكاردوا ان حتى لو الدولة اقل كفاءة فى انتاج سلعتين‬
‫ممكن تستفيد من التجارة انها تنتج السلعة اللى هيا كفاءتها اقل فيها بنسبة‬
comparative advantage ‫ وكدة هيا عندها ميزة نسبية‬.. ‫صغيرة‬
Table (2)
U.S.
U.K.
Wheat (bushels/labor hour)
6
1
Cloth (yards/labor hour)
4
2
Step one
‫ لو لقيت دولة‬..‫تشوف انهى دولة بتنتج اكتر‬
comparative ‫واحدة… يبقى دى حالة‬
adv
Step two: we get Relative price =
𝑃𝑥
𝑃𝑦
𝑌
=𝑋
‫ و الدولة‬..‫و بعمل النسبة دى لكل سلعة في كل دولة‬
In U.S
In U.K
‫اللى سعرها اقل يبقى هيا االكفأ‬
• Pw/Pc = C/W = 4/6 = 0.67 cloth for 1 wheat
• Pw/Pc = C/W = 2/1 = 2 cloth for 1 wheat
• Pc/Pw = W/C = 6/4 = 1.5 wheat for 1 cloth
• Pc/Pw = W/C = 1/2 = 0.5 wheat for 1 cloth
Pw/Pc = relative price of wheat
Pc/Pw = relative price of cloth.
The nation will that has lower price, will specialize in this commodity & export it.
Range of mutual trade is the difference between the two nations domestic prices
0.67 C < 1W < 2 C
0.5 W < 1C < 1.5 W
Us domestic < Pw/Pc< UK domestic
UK domestic < Pc < US domestic
The closer the terms of trade to the domestic price of nation (1) nation (2) gain more.
In this case U.S has comparative advantage in wheat, and U.K has comparative advantage in cloth.
The case of NO comparative advantage
‫ متساوى يبقى كده انا مقدرش اعرف انهي دوله‬Relative price ‫لو جيت حسبت األسعار النسبية في الدولتين على بعض و لقيت ان ال‬
.‫ و في الحاله دي مفيش تجاره‬Comparative advantage ‫عندها‬
Pw/Pc
Table (3)
U.S.
U.K.
Wheat (bushels/labor hour)
6
3
Cloth (yards/labor hour)
4
2
4/6= 0.67
2/3=0.67
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2nd year
international Economics- Part (3)-AMT
Exam questions on Trade theory
1. The Mercantilists did not advocnte:
a.free trade
b.stimulating the nation's exports
C.restricting the nations' imports
d. the accumulation of gold by the nation
2.According to Adam Smith, international trade was based on:
a. absolute advantage
b. comparative advantage
c. both absolute and comparative advantage
d. neither absolute nor comparative advantage
3. The absolute advantage theory of Adam Smith,
a.explains most of trade among developed nations
b. explains most of trade among developing nations
C.most of current world trade
d. is a special case of the Ricardian comparative advantage theory
4. The commodity in which the nation has the smallest absolute disadvantage is the
commodity of its:
a. absolute disadvantage
b. absolute advantage
c. comparative disadvantage
d.comparative advantage
5. If in a two-nation (A and B), two-commodity (X and Y) world, it is established that
nation A has a comparative advantage in commodity X, then nation B must have:
a. an absolute advantage in commodity Y
b. an absolute disadvantage in commodity Y
C.a comparative disadvantage in commodity Y
d. a comparative advantage in commodity Y
6. If with one hour of labor time nation A can produce either 3X or 3Y while nation B can
produce either 1X or 3Y (and labor is the only input):
a. nation A has a comparative disadvantage in commodity X
b. nation B has a comparative disadvantage in commodity Y
c. nation A has a comparative advantage in commodity X
d. nation A has a comparative advantage in neither commodity
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2nd year
international Economics- Part (3)-AMT
7. If before trade the price of X in terms of Y in nation A is 1X =3 Y but in nation B the
price is 2X=4Y that means
a. nation A has a comparative advantage in X
b. nation B has a comparative advantage in X
c. nation B is eligible to import X when trade opens
d. nation A is eligible to import Y when trade open
8. If before trade 3 of X are traded for 6 of Y in nation (A) but in nation (B) 4 of X are
traded for 8 of Y then
a. trade will benefit nation B more than benefit A
b. trade is expected to be more beneficial to nation A than nation B
C. trade will be equally beneficial for both nations
d. none of the above is true
9. If domestically 3X=3Y in nation A, while 1X=2Y domestically in nation B if after trade
the terms of trade is such that 1X =1.5 Y then
a. a, nation B gains more from trade than nation A
b. nation A gains more from trade than nation B
c. the two nations equally benefited from trade
d. none of the above is true
10. Ricardo explained the law of comparative advantage on the basis of:
a. the labor theory of value
b. the opportunity cost theory
c. the law of diminishing returns
d. all of the above
true or false.
1.
2.
a
a
3.
d
4.
d
5.
d
6.
c
7.
b
8.
d
9.
c
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10.
a
Page 3
2nd year
international Economics- Part (3)-AMT
Chapter (2)
Continue Trade theory with Opportunity cost
◼ Comparative Advantage and Opportunity Costs
◼ The original idea of comparative advantage was based on the labor theory
of value: The value or price of a commodity depends exclusively on the
amount of labor used to produce it.
◼ We Can use the opportunity cost theory to explain comparative advantage:
◼ the opportunity cost of (X) is the amount of good (Y) given up by using
its resources to produce one unit of (X).
◼ Example: producing 1 unit of washing machines make us given up
producing 3 heaters, the cost of washing mashing = 3 heaters
◼ Production Possibilities Frontier
◼ A curve that shows alternative combinations of the two commodities a nation
can produce by fully using all resources with best available technology.
◼ Constant opportunity costs arise when:
1. Resources are either perfect substitutes for each other or used in fixed
proportion in production of both commodities, and
2. factors of productions are homogeneous.
Example
•
Opportunity cost of cars (P.cars/P.mobiles)
= 12/4 = 3 mobiles for 1 car
•
Opportunity cost of cars (P.cars/P.mobiles) =
12/8 = 1.5 mobiles for 1 car “more efficient”
•
Opportunity cost of mobiles (P.mobiles/P.cars)=
4/12 =1/3 car for 1 mobile “more efficient”
•
Opportunity cost of mobiles (P.mobiles/P.cars)=
8/12 =2/3 car for 1 mobile
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2nd year
international Economics- Part (3)-AMT
How to get comparative advantage using PPF
◼ In the absence of trade, a nation’s production possibilities frontier also
represents its consumption frontier.
◼ Increased output resulting from specialization and trade represents nations’
gains from trade, allowing nations to consume outside production possibilities
frontier.
So, let’s say without trade
•
U.S produce and consume 90W and 60 C…. point A
•
U.K produce and consume 40W and 40 C… point A’
This Figure shows that:
 the slope of the U.S. PPC is 120/180 =2/3 = opportunity cost of wheat in US. (Pw/Pc)
 The slope of the U.K. PPC is 120/60 = 2 = opportunity cost of wheat in U.K (Pw/Pc)
✓ Thus, PW /PC = 2/3 in the United States, and inversely PC /PW= 3/2 = 1.5.
✓ In the United Kingdom, PW /PC = 2, and PC /PW = 1/2.
The lower PW /PC in the United States (2/3 as opposed to 2) is a reflection of its
comparative advantage in wheat. Similarly, the lower PC /PW in the United Kingdom
(1/2 as opposed to 2/3) reflects its comparative advantage in cloth.
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2nd year
international Economics- Part (3)-AMT
The gains from trade
◼ Under constant cost conditions, nations will completely specialize in their
comparative advantage .
◼ With complete specialization in both nations, the equilibrium-relative
commodity price of each commodity lies between the pretrade relative
commodity price in each nation.
Before
specialization
After
Specialization
w
90
180
PRODUCTION gain for world output
US
UK
World
c
w
c
w
c
60
40
40
130
100
0
0
120
180
120
Consumption gain
US
UK
Before trade
After trade
w
90
110
c
60
70
w
40
70
c
40
50
Change
+20
+10
+30
+10
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2nd year
international Economics- Part (3)-AMT
Question (1): Choose the correct answer
1. Consider the figure. In the absence of trade, Canada would produce and consume:
a. 8 televisions and 16 refrigerators
b. 12 televisions and 16 refrigerators
c. 8 televisions and 12 refrigerators
d. 12 televisions and 8 refrigerators
2. Referring to the figure, Canada has a comparative advantage in:
a. Televisions
b. Refrigerators
c. Televisions and refrigerators
d. Neither televisions nor refrigerators
3. Consider the figure. With specialization, Canada produces:
a. 16 televisions
c. 8 televisions and 16 refrigerators
b. 12 televisions and 8 refrigerators
d. 24 refrigerators
4. Consider the figure With trade, Canada consumes:
a. 12 televisions and 8 refrigerators
c. 8 televisions and 16 refrigerators
b. 12 televisions and 16 refrigerators
d. 24 refrigerators
5. According to the figure, exports for Canada total:
a. 16 refrigerators
b. 8 refrigerators
c. 12 refrigerators
d. 16 refrigerators
6. According to the figure, imports for Canada total:
a. 6 televisions
b. 8 televisions
c. 12 televisions
d. 16 televisions
7. In Adam Smith's trade theory, ______ is the only factor of production and is of one quality
(homogeneous)
a. Land
b. labor
c. capital
d. entrepreneurship
8. Suppose that a country's post-trade consumption point lies inside of its production
possibilities curve. This means that the country
a. gains from trade
c. is not affected by trade
b. loses from trade
d. none of the above
9. Suppose that a country's post-trade consumption point lies outside of its production
possibilities curve. As a result, the country
a. gains from trade
c. is not affected by trade
b. loses from trade
d. none of the above/
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2nd year
international Economics- Part (3)-AMT
10. If a production possibilities schedule appears as a downward sloping straight line, there
occurs
a. increasing opportunity cost
c. constant opportunity cost
b. decreasing opportunity cost
d. negative opportunity cost
11. In a two-product, two-country world, international trade can lead to increases in:
a. Consumer welfare only if output of both products is increased
b. Output of both products and consumer welfare in both countries
c. Total production of both products, but not consumer welfare in both countries
d. Consumer welfare in both countries, but not total production of both products
12. If with one hour of labor time nation A can produce either 3X or 3Y while nation B can produce
either 1X or 3Y (and labor is the only input):
a. Px/Py=1 in nation A
b. Px/Py=3 in nation B
c. Py/Px=1/3 in nation B
d. all of the above
13. With reference to the statement in Question 6, if 3X is exchanged for 3Y:
a. nation A gains 2X
b. nation B gains 6Y
c. nation A gains 3Y
d. nation B gains 3Y
14. With reference to the statement above , the range of mutually beneficial trade between nation A
and B is:
a) 3Y < 3X < 5Y
b) 5Y < 3X < 9Y
c) 3Y < 3X < 9Y
d) 1Y < 3X < 3Y
15. If domestically 3X=3Y in nation A, while 1X=1Y domestically in nation B:
a) there will be no trade between the two nations
b) the relative price of X is the same in both nations
c) the relative price of Y is the same in both nations
d) all of the above
1)
c
2)
b
Answers….
3)
4)
d
b
5)
b
6)
c
7)
b
8)
b
9)
a
10)
c
11)
b
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12)
d
13)
b
14)
c
Page 8
15)
D
2nd year
international Economics- Part (3)-AMT
Problem : (Mid-Term 2016 Economics)Study the following graph and answer the questions
below:
(The bold line is the production possibility curve)
Wheat
200
130
120
1.
2.
3.
4.
5.
6.
7.
120 140 200
What is the product of comparative advantage of this country?
What is the internal rate of exchange?
What is the international rate of exchange?
What is the size of imports and exports?
What is the gain from trade in both products?
What is the production of both products after trade?
What is the production of both products before trade?
400
Cloth
1. The country specialized in wheat, then wheat is its comparative advantage.
2. Internal rate (or opportunity cost cloth) = 200/200 = 1.. Pc/Pw (price of cloth in terms of
wheat)
3. International rate of exchange (slope of trade line) = 200/400= 0.5, Pc/Pw …Pw/Pc=2
4. Exports= specialization point – consumption after trade= 200-130 = 70 W
Imports = consumption of cloth after trade= 140 C
5. Gain in wheat = 130-120 = 10 …………………Gain in cloth= 140 -120 = 20
6. After trade production of wheat= 200 and of cloth = ZERO
7. Before trade production of wheat = 120 and of cloth = 120
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2nd year
international Economics- Part (3)-AMT
True or False
1. According to the principle of absolute advantage, international trade is beneficial to the world if
one nation has an absolute cost advantage in the production of one good while the other nation
has an absolute cost advantage in the other good.
2. The principle of absolute advantage asserts that mutually beneficial trade can occur even if one
nation is absolutely more efficient in the production of all goods.
3. The basis for trade is explained by the principle of absolute advantage according to David
Ricardo and the principle of comparative advantage according to Adam Smith.
4. The principle of comparative advantage contends that a nation should specialize in and export
the good in which its absolute advantage is smallest or its absolute disadvantage is greatest.
5. Assume that the United States is more efficient than the United Kingdom in the production of all
goods. Mutually beneficial trade is possible according to the principle of absolute advantage, but
is impossible according to the principle of comparative adv.
6. It is possible for a nation not to have an absolute advantage in anything; but it is not possible for
one nation to have a comparative advantage in everything and the other nation to have a
comparative advantage in nothing.
7. Constant opportunity costs suggest that the relative cost of producing one product in terms of the
other will remain the same no matter where a nation chooses to locate on its productionpossibilities schedule.
8. A nation's trade triangle denotes its exports, imports, and terms of trade.
9. International trade leads to increased welfare if a nation after trade consumer point under its
production possibility.
1.
T
2. F
3. F
4. F
Answers
5. F
6. F
7. T
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8. T
9. F
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