QUESTIONS FOR REVIEW
1. What are the basic questions that we seek to answer in this chapter? In what way is
the model presented in this chapter an abstraction or a simplification of the real
world? Can the model be generalized?
In this chapter, we can understand three main parts, including the law of comparative
advantage, the relationship between opportunity costs and relative commodity prices and
the basis for trade and show the gains from trade under constant costs conditions.
The model is an informative representation of an object, person or system and it can be
generalized.
2. What were the mercantilists’ views on trade? How does their concept of national
wealth differ from today’s view?
The mercantilists’ view on trade claimed that the way for a nation to become rich and
powerful was to export more than it imported. The resulting export surplus would then be
settled by an inflow of bullion, or precious metals, primarily gold and silver. The more
gold and silver a nation had, the richer and more powerful it was.
The mercantilists measured the wealth of a nation by the stock of precious metals it
possessed. In contrast, today we measure the wealth of a nation by its stock of human, manmade, and natural resources available for producing goods and services.
3. Why is it important to study the mercantilists’ views on trade? How were their views
different from those of Adam Smith? What is the relevance of all this today?
The mercantilists’ view on trade are appropriate until now in trade policy as it suggests the
way for the country to develop, utilizing surplus in export. In addition to that, mercantilists’
view on trade has advantages by creating jobs for people and protect the essential industry
of a nation.
The view is a completely different economic strategy from what Adam Smith advised in
the Wealth of Nations that encourages the viewpoint of free market and invisible hands to
develop the economy.
Like I have mentioned, the mercantilists’ view on trade still appropriate nowadays in the
way it encourage country to foster export surplus and in many trade policies.
4. What was the basis for and the pattern of trade according to Adam Smith? How
were gains from trade generated? What policies did Smith advocate in international
trade? What did he think was the proper function of government in the economic
life of the nation?
Adam Smith claimed that absolute cost difference or absolute advantage is the basis of
trade and that a country will export that commodity it has an absolute advantage and import
that commodity in which it has an absolute disadvantage. In addition, he argued that by
giving everyone freedom to produce and exchange goods would foster greater prosperity
than with stringent government regulations.
He said that a free market would be beneficial to everyone and that if the government would
stay out of the system as it can prevent the development of the economy and that the
business would create money and goods on their own.
5. In what way was Ricardo’s law of comparative advantage superior to Smith’s theory
of absolute advantage? How do gains from trade arise with comparative advantage?
How can a nation that is less efficient than another nation in the production of all
commodities export anything to the second nation?
In the case when there is no comparative advantage that comparative advantage theory is
superior to Adam Smith’s theory. This occurs when the absolute disadvantage that one
nation has with respect to another nation is the same in both commodities.
Production specialization according to comparative advantage, not absolute advantage,
results in exchange opportunities that lead to consumption opportunities beyond the
PPC. Trade between two agents or countries allows the countries to enjoy a higher total
output and level of consumption than what would have been possible domestically.
Even if one nation has an absolute disadvantage with respect to the other nation in the
production of both commodities, there is still a basis for mutually beneficial trade, unless
the absolute disadvantage (that one nation has with respect to the other nation) is in the
same proportion for the two commodities.
6. What is the exception to the law of comparative advantage? How prevalent is it?
The law of comparative advantage was developed by David Ricardo in 1817 to explain the
reason behind international trade between countries even when one country's businesses,
factories, and workers are more efficient at producing every single good than the other
country.
The exception is when there is no comparative advantage to any nation their is no scope
for beneficial trade between them.
7. Why is Ricardo’s explanation of the law of comparative advantage unacceptable?
What acceptable theory can be used to explain the law?
David Ricardo's explanation of the law of comparative advantage was based on the labor
theory of value, which is not an acceptable theory of value. The law of comparative
advantage can be based off the opportunity cost theory which is acceptable by the theory
of value.
PROBLEMS
1. TABLE 2.5
In case A, the United States has absolute advantage in wheat and the United Kingdom in
cloth.
In case B, the United States has an absolute advantage in both commodities.
In case C, the United States has an absolute advantage in wheat but has neither an absolute
advantage nor disadvantage in cloth.
In case D, the United States has an absolute advantage over the United Kingdom in both
commodities.
2. TABLE 2.5
In case A, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case B, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case C, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case D, the United States and United Kingdom have a comparative advantage in neither
commodities.
3. TABLE 2.5
In case A, trade is possible based on absolute advantage.
In case B, trade is possible based on comparative advantage.
In case C, trade is possible based on comparative advantage.
In case D, trade is possible based on absolute advantage that the United States has over the
United Kingdom is the same in both commodities.
4. TABLE 2.5.
a. Chuyển đơn vị
-
Bushels/ hour => labor
Metre/ labor
Nếu đơn vị lao động nằm ở mẫu số => productivity (năng suất)
Hour nằm ở tử số => chi phí sản xuấtcv
Năng suất => nghịch đảo để thành chi phí sản xuất
b. Xác định comparative advantage
W/C
C/W
US
1W = ¾ 1C
1C=4/3 1W
UK
1W=2C
1C =1/2W
 Wus/Cus < Wuk/Cuk (3/4<2)
 US has comparative advantage in the production of wheat and specialize in
production of wheat.
 US export wheat and import cloth.
c. Tỉ lệ trao đổi quốc tế
World exchange rate:
3/4C < 1W < 2C
1/2 W< 1C< 4/3W
d. Gain from world exchange rate:
World exchange rate: 1W =1C
US has domestic exchange rate: 1W=3/4C
 US gain form trade: 1 - 3/4C= 1/4C
e. Draw the frontier
Completely specialization producing
Total amount unit of resources: 30 (tự assume)
Resource
Wheat
30
180
25
150
20
120
0
0
O
5
10
30
Cloth
0
20
40
120
-
Trường hợp tự cung tự cấp: autarky (đóng cửa nền kinh tế)
+ Trường hợp ko trade: giới hạn khả năng sản xuất – trùng với đường giới hạn khả năng
tiêu dùng
US producr & consume at (90W, 60C)
+ Trade happens (40W=40C)
 US export 40 wheat, import: 40C (world exchange rate 1W=1C)
 US consume (50W, 100C) – điểm nằm ngoài đường khả năng tiêu dùng của US (FIGURE
2.2. GAIN form trade
- Tỉ lệ trao đổi quốc tế nằm giữa 2 đường khả năng tiêu dùng của 2 nations.

(a) The United Kingdom gains 1C
(b) The United Kingdom gains 4C
(c) 3C < 4W < 8Z
(d) The United States would gain 3C while United Kingdom would gain 2C.
5. TABLE 2.5
(a) The cost in terms of labor content of producing wheat is 1⁄4 in the United States and 1
in the United Kingdom, while the cost in terms of labor content of producing cloth is 1/3
in the United States and 1⁄2 in the United Kingdom.
(b) In the United States, Pw = $1.50 and Pc = $2.00. (c) In the United Kingdom, Pw =
$1.00 and Pc = $0.50
6. TABLE 2.5.
(a) With the exchange rate of £1 = $2, Pw = $2.00 and Pc = $1.00 in the United Kingdom,
so that the United States would be able to export wheat to the United Kingdom and the
United Kingdom would be able to export cloth to the United States.
(b) With the exchange rate of £1 = $4, Pw = $4.00 and Pc = $2.00 in the United Kingdom,
so that the United States would be able to export wheat to the United Kingdom but the
United Kingdom would not be able to export cloth to the United States.
(c) With the exchange rate of £1 = $1, Pw = $1.00 and Pc = $0.50 in the United Kingdom,
so that the United Kingdom would be able to export both commodities to United States.
7. TABLE 2.5
(a)
(b) In the United States Pw/Pc = 3⁄4, while in the United Kingdom, Pw/Pc = 2.
(c) In the United States Pc/Pw = 4/3, while in the United Kingdom, Pc/Pw = 1/2.