STT: 10
Chapter 1: Introduction to International economics
What is international economics about?
International economics is about how nations interact through trade of goods and services,
through flows of money and through investment
IE: Trade, Invest, Finance
 KTQT1 focus on international trade
Why do we trade?
Countries (or firms in different countries) trade with each other because they benefit from it!
Specifically, we trade
- to get goods and services that cannot be produced at home
- to get cheaper goods & services than those produce at home
Ex: production cost of car in VN much > than foreign countries so we trade - import
- to achieve economies of scale
(Economies of scale: quantity increase -> decrease production cost)
- to grow faster
The classical theory of IT is concerned with 3 questions:
1.
What are the gains from trade?
Where do the gains come from, and how are they divided among the trading countries?
2.
What is the structure/pattern of trade?
Which goods/services are exported, and which are imported?
3.
What are the terms of trade?
At what price are the exported and imported goods exchanged?
Characteristic of International Trade
 Figure 1.1: Compare export and import value:
- Import value > export value => Trade deficit
- Only US case, but VN also trade deficit
- For many countries in the world reach trade deficit situation
Figure 1-2  role of IT is very important, in Belgium the trade counts for 90%. Why for some
countries (Swiss, Belgium, Singapore…) the IT counts so much?
Why? International trade increase so fast
- New technology and innovation
- Trend of globalization
Not focus on globalization only, trend of new protectionism
Lecture 2. Trade theories
Why trade occurs?
- Difference in the preferences (trade between countries)
- Difference in factor endowments
Industries that need capital
- Difference in technology
Y = A*K^alpha*Lˆbeta*T
TFP – total factor of productivity
The different trade theories: 2 categories
1. Classica trade theory: Adam Smith, Ricardian model
2. Modern Trade Theory:
1. Absolute Advantage theory (Adam Smith)
Productivity/h
wheat (kg)
cotton (m)





US
6
4
Vietnam
1
5
Absolute productivity (of Wheat, US = 6kg) – (of Cotton, VN = 5m)
Relative productivity (of Wheat, US = 6/4 = 3/2) – (of Cotton, VN = 5/1 = 5)
Compare the productivity of wheat and the productivity of cotton
Unit labor requirement
(of Wheat, US = 1/6 h, in cotton = ¼ h) – (of Cotton, VN = 1/5h, US = 1h)
Need how many hours to produce 1 product per labor?
Inverse of absolute productivity
Opportunity cost (of Wheat, US = 2/3 cotton) – (of Cotton, VN = 1/5 wheat)
Inverse of relative productivity
1h = 6W = 4C  W = 4/6C = 2/3C
Relative price (of Wheat, US = 2/3) – (of Cotton, VN = 1/5)
= Opportunity cost
Value của Opportunity cost & Relative price = nhau, chỉ khác ở RP o có đơn vị còn OC có
- The advangtage 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. (or lower
unit labor requirement/ or higher absolute productivity)
 US has absolute advantage in production of wheat industry, Vietnam has absolute
advantage in production of cotton industry.
 Role of specialization, 2 countries can gain benefit from trade
 Country has absolute advantage in 1 product  should specialize in it and export to
others
Change a little bit:
Hour/product
wheat (kg)
cotton (m)
US
6h
4h
Vietnam
1h
5h
 With wheat, VN is more efficient than US – with cotton, US is more efficient than VN.
-
Adam Smith model: 2x2 (2 – countries, 2 – products)
Only 1 factor production: labor
-
(≠ H – O model: 2x2x2 with 2 = countries, 2 = products, 2 = factor productions)
-
Why trade?
Adam Smith: different in absolute productivity
(≠ Ricardian: relative productivity)
2. Comparative Advantage theory (Ricardian model)
-
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 (or lower opportunity cost/ or
higher relative productivity) than it could be in the other country.
Productivity/h
wheat (kg)
cotton (m)
US
6
4
Vietnam
1
2
- In the US, 1W = 2/3 C
- In Vietnam, 1W = 2C
 US has comparative advantage in wheat
Vietnam has comparative advantage in cotton
 Ex: US has absolute advantage in any industry  but VN can still export because it has comparative
advantage in cotton (drawback of Adam Smith model)
 never 1 country has comparative advantage in 2 industries
3. Ricardian model – Law of Comparative Advantage
-
David Ricardo developed the theory of comparative advantage.
According to this theory, specialization and free trade will benefit all trading partners,
even the absolutely less efficient producers.
Hour/product
PC
cotton (m)
-
US
2
5
Vietnam
7
6
Absolute advantage belongs to US: PC and cotton
Comparative advantage:
US has comparative advantage in PC (PC = 2/5 Cotton)
Vietnam has comparative advantage in cotton (Cotton = 6/7 PC)
US:
1 PC = 2h  1h = ½ PC
1 Cotton = 5h  1h = 1/5 Cotton
 PC: ½ PC = 1/5 Cotton
1/5
𝑃𝐶
 𝑊 = 1/2 = 𝐶𝑜𝑡𝑡𝑜𝑛
Gain from Mutual Absolute advantage
Productivity/h
wheat (kg)
cotton (m)
New Zealand
600
200
Assume: (a) two countries with fixed amount of land
(b) only two products produced (wheat and cotton)
Production Possibilities fratire (PPF)
Australia
200
600
Change axis:
NZ has advantage in wheat -> specialize in wheat and export to AUS
AUS has advantage in cotton -> specialize in cotton and export to NZ
AUS
New Zealand
𝑄𝑤
𝑄𝑐
𝑄𝑤
𝑄𝑐
Specialization
600
0
0
600
After trade
300 (=600-300,
export to
Australia)
300 (imported
from Australia)
300 (imported
from NZ)
300 (exported
to NZ)
Gain from trade
Compare A to A*
Gain from trade = 200 Cotton
(Or) 200
NZ has advantage in wheat -> specialize in wheat and export to AUS
AUS has advantage in cotton -> specialize in cotton and export to NZ
Mid term test focus on International Trade Theories
Final: 12 MCQ, btap ve INT trade policies
2 mcq on absolute, 2 on comparative,
Half
Exercise: INT trade policies
Gain from trade
 Several ideas
1.
2. How could a country that is the most (least) efficient producer of everything gain from
trade?
3. Trade is predicted to benefit a country by making it more efficient when it exports goods
which use abundant resources and import goods which use scare resources
4. When countries specialize, they may also be more efficient due to large scale production
 more production, less cost per unit
5. Countries may also gain by trading current resources for future resources (lending and
borrowing)

Trade is predicted to benefit countries as a whole in several ways, but trade may harm
particular groups within a country.
Mutually benefit  every country gain from trade but there are different group, people in each
country  trade affect them differently, decide on specific markets
When import at the cheaper price than domestic production  consumer happy, market
become more competitive, domestic suppliers loose benefits
o International trade can adversely affect the owners of resources that are used
intensively in industries that compete with imports
o Trade may therefore have effect on the distribution of income within a country
Xung đột trong 1 qgia > ngoài
Ex: Nh nhóm ng khác nhau trong qgia phản đối gov tgia tổ chức thương mại qte do họ bị ảnh
hưởng
o
Adam Smith , The Wealth Of Nations, Book I, Chapter I, p. 22, para. 10.
“It is the maxim of every prudent master of a family, never to attempt to make at home what it
will cost him more to make than to buy... What is prudence in the conduct of every private
family, can scarce be folly in that of a great kingdom.”
 where produce cheaper so buy them, always based on the cost of making that thing
 compare cost of production through different models
Pattern of Trade

Differences in climate and resources can explain why Brazil exports coffee and Australia
exports iron ore.



But why does Japan export automobiles, while the US exports aircraft?
Differences in labor productivity may explain why some countries export certain
products.
How relative
The Effects of Government Policies on Trade

Policy makers affect the amount of trade through
Technical barriers
o tariffs: a tax on imports or exports  collect money from trade  welfare
increase due to the amount of ex/imports  chính phủ có thêm tiền nma ch
chắc country gain welfare on total  cần tính gain from sum of different groups
o quotas: a quantity restriction on imports or exports
o export subsidies: a payment to producers that export,
o or through other regulations (e.g., product specifications) that exclude foreign
products from the market, but still allow domestic products.
Consider basic & popular policies
Effect of government policies on different groups (producers, consumers, gov)





What are the costs and benefits of these policies?
Economists design models that try to measure the effects of different trade policies.
If a government must restrict trade, which policy should it use?
If a government must restrict trade, how much should it restrict trade?
If a gov restricts trade, what are the costs if the foreign governments respond likewise?
Trade sanction  very reasonable to respond in a single way (if 1 party apply tariff on
others, can be understandable that they will do it back)
Case study – Donald Trump on Trade


What does Donald Trump stand on International Trade?
What are Trump’s proposed Trade Policies? What are these policies aimed at?
- “I’ve been moving clothing-making from China and Mexico to the US”
Protectionism
Gain from loss of other nations
- "Our country is in serious trouble. We don't win anymore. We don't beat China in trade.
We don't beat Japan, with their millions and millions of cars coming into this country, in
trade. We can't beat Mexico, at the border or in trade."
Source: Fox News Top Ten First Tier debate transcript, Aug 6 2015
-
“I'm sick of always reading about outsourcing. Why aren't we talking about "onshoring"
(quay về bờ)? We need to bring manufacturing jobs back home where they belong.
Onshoring, or "repatriation," is a way for us to take back the jobs China is stealing. We
know that China's wages are increasing. Also, China lacks certain natural resources that
we have in abundance. If we exploit those two key facts, we can begin making the case
to companies that they should bring their manufacturing facilities home to America”
Source: Time to Get Tough, by Donald Trump, p. 37-39, Dec 5, 2011
 DT follows nationalism
-
You would end NAFTA, kill TPP, impose tariffs on some products like 35% on Ford cars
made in Mexico.
• TRUMP: I am all for free trade, but it's got to be fair. When Ford moves their massive
plants to Mexico, we get nothing. I want them to stay in Michigan.
Q: But the American Enterprise Institute says, your Trump Collection clothing line, some
of it is made in Mexico and China.
• TRUMP: That's true. I want it to be made here.
• Q: The point is you're doing just what Ford is--you're taking advantage of a global
trading market.
TRUMP: | never dispute that. I just ordered 4,000 television sets from South Korea. I
don't want to order them from South Korea. I don't think anybody makes television sets
in the United States anymore. I talk about it all the time. We don't make anything
anymore.
Source: Fox News Sunday 2015 Coverage of 2016 presidential hopefuls, Oct 18, 2015.
-
If we want jobs in America, we need to enact my 5-part tax policy: .. . mandate a 15%
tax for outsourcing jobs and a 20% tax for importing goods.
Source: Time to Get Tough, by Donald Trump, p. 65, Dec 5, 2011
Trade Openess Index
𝐸𝑋 + 𝐼𝑀
𝐺𝐷𝑃
Show the power of the economy compared to the NX, not the openness
Eg: The more the economics affected by Covid 19, the more it depends on exports & imports
Exports of goods and services (% of GDP)
Imports of goods and services (% of GDP)
Open Markets Index (OMI)
-
-
Observed trade openness
o Trade-to-GDP ratio
o Merchandise imports per capita ratio
o Trade per capita ratio
o Real merchandise import growth
Trade policy
Openness to capital flows
Trade-enabling infrastructure
Trends in international trade
Who are the main players in international trade?
INTERNATIONAL TRADE
INT’L TRADE THEORIES
• Why do countries trade? (What determines which products a country exports and which
products it imports?)
• How does trade affect production and consumption in each country?
• How does trade affect the economic well-being of each country? In what sense can we say
that a country gains or losses from trade?
• How does trade affect the distribution of economic wellbeing or income among various
groups within the country? Can we identify specific groups that gain from trade and other
groups that lose because of trade?
Supply, Demand and Trade in a Single Industry
• Let's construct a model measuring how a tariff affects a single market, say that of wheat.
• Suppose that in the absence of trade the price of wheat in the foreign country is lower than
that in the domestic country.
o With trade the foreign country will export: construct an export supply curve
o With trade the domestic country will import: construct an import demand curve
Domestic price of wheat  higher
• An export supply curve is the difference between the quantity that foreign producers supply
minus the quantity that foreign consumers demand, at each price.
• An import demand curve is the difference between the quantity that domestic consumers
demand minus the quantity that domestic producers supply, at each price.
The lower price  The more demand for import, less supply

In equilibrium,
import demand = export supply
domestic demand – domestic supply = foreign supply – foreign demand

In equilibrium,
world demand = world supply


Demand: What determined the quantity of products demanded?  Price
Consumer surplus measures the amount that a consumer gains from a purchase by the
difference in the price he pays from the price he would have been willing to pay.
o Lower price  higher welfare of consumer


Supply:
Producer surplus measures the amount that a producer gains from a purchase by the
difference in the price he receives from the price he would have been willing to sell.
o Higher price  more welfare of producer
o A net gain of producers – the differences between the revenues received and the
costs incurred.
A national market with no trade
Open when demand – supply not at equilibrium
Two national Markets and the Opening of Trade
The United States (US)
𝑆𝑈𝑆 = 25𝑃 − 10,000
𝐷𝑈𝑆 = −25𝑃 + 90,000
The rest of the world
𝑆𝑓 =
250
25,000
𝑃−
3
3
250
𝐷𝑓 = − 3 𝑃 +
No trade equilibrium
𝑃𝑈𝑆 = $2000
325,000
3
No trade equilibrium
𝑃𝑓 = $700
Free-Trade Equilibrium
 P = $2000
Tính xem gain/loss from trade = cách lấy (CS + PS) mới – (CS + PS) ban đầu của từng bên
Exercise:
The equation for the demand curve for writing paper in Belgium is
P = 700 - 2QD
The equation for the supply curve for writing paper in Belgium is
P = 40 + (Qs/5)
• What are the equilibrium price and quantity if there is no international trade?
• What are the equilibrium quantities for Belgium if the nation can trade freely with the rest of
the world at a price of 120?
• What is the effect of the shift from no trade to free trade on Belgian consumer surplus? On
Belgian producer surplus? What is the net national gain or loss for Belgium
RICARDIAN MODEL
MERCANTILISM (cn trọng thương)
A nation’s wealth n economic strength = its gold n silver stores
Trade = selling n buying
HOME
export goods, receive
gold
import goods, give gold
FOREIGN
EXPORT > IMPORT
Mecantilism: a zero-sum game (1 nước được 1 nước mất, tổng lượng vàng trên tgioi kh đổi)
 Welfare increases w exports: exports increase, gold accumulates more.
 Welfare decreases w imports: imports increase, gold reserve reduces.
=> Trade only dtermined their distribution among the various nations
=> Mercantilists asumed trade to be a zero-sum game (fixed amounts of goods n of gold
existed in the world)
 Gov Policies
o Restricting imports, pushing exports
o Protecting its traders n maximising income
eg: The Tavigation Acts tightened England’s control of the American economy n
trade.
-> Adam Smith: 1 chủ gđ khôn ngoan sẽ kbh tự làm nếu có thể mua với cost rẻ hơn.
Absolute Advantage
Suppose country A n country B produce wheat, but that A’s climate is more suited to wheat n
its labor is more productive.
Country A will therefore produce more wheat per hectare than country B n use less labor in
growing it n bringing it to the market.
Country A thus enjoys an absolute advantage over country B in the production of wheat.
Gains from Mutual Absolute Advantage
Trade enables both countries to move beyond their previous resource n productivity
constraints.
Both countries (after trade) can consume beyond their production possibilities.
=> Absolute Advantage: The advantage in the production of a product enjoyed by 1 country
over another when it uses fewer resources to produce that product than the other country
does.
A
B
Wheat (ton/h)
5
3
Textile (m/h)
4
7
Comparative Advantage
Wheat (ton/h)
Textile (m/h)
A
5
7
B
3
4
Law of Comparative Advatage: Specialization n free trade will benefit ALL trading partners,
even the absolutely less efficient producers.
The Ricardian model uses the concepts of opportunity cost n comparative advantage.
The OC of producing sth measures the cost of not being able to produce sth else.
USA
India
Computer (1 worker/day)
5c
1c
Cloth (1 worker/day)
15m
5m
Limited working resources -> trade off
A country has a comparative ad in producing a good if the OC of producing that good is lower in
the country than it is in other countries.
A country w a comparative ad in producing a good uses its resources more efficiently when it
produces that good compared to other uses.
Change in outputs
Computers
Cloth
Computer (1 worker/day)
+5x
-15x
Cloth (1 worker/day)
-y
+5y
World
5x-y
-15x+5y
(tồn tại x và y để cả comp và cloth của world lớn hơn 0)
OC n PPF
USA
India
Computers
Meters of Cloth
Computers
Meters of Cloth
100
0
60
0
90
30
20
100
50
150
30
150
0
300
0
300
Cloth (meters)
Cloth (meters)
300
300
100
Computers
60
Computers
The production possibility frontier (PPF) of an economy shows the maximum amount of a goods
that can be produced for a fixed amount of resources
When the economy uses all of its resources, the OC is equal to the absolute value of the slope
of the PPF, n it is constant when the PPF is a straight line.
Specialization n Trade
USA
India
Domestic Production n
A(50c, 150m)
A’(40c, 100m)
Consumption
Full specialization
B(100c, 0m)
B’(0c, 300m)
(production)
Domestice Consumption
D(50c, 175m)
D’(50c, 125m)
after Trade (1 đổi 3,5)
Gains from Trade
+25m
+10c, +25m
Cloth (meters)
300
import
350
300
Cloth (meters)
Slope = -4
100
Computers
60
Computers
Terms of trade (TOT): refers to the relative price of exoprts in terms of imports n is defined as
the ratio of export prices to import prices Px/Pm
It can be interpreted as the amount of import goods an economy can purchase per unit os
export goods.
(TOT)USA x (TOT)India = 1
Compared ToT n the autarky relative price of the exported goods
USA: In autarky (Pcomp/Pcloth)US = 3
(1) Trade at the ratio 1c = 4m -> (ToT)US = 4
(2) Trade at the ratio 1c = 3,5m -> (ToT)US = 3.5
Gains from trade (1) > (2)
India: In autarky (Pcloth/Pcomp)US = 1/5
(1) Trade at the ratio 1c = 4m -> (ToT)US = 1/4
(2) Trade at the ratio 1c = 3,5m -> (ToT)US = 1/3.5
Gains from trade (1) > (2)
We show how consumpsion possibilities expand beyond the production possibility frontier
when trade is allowed.
Without trade, consumption is restricted to what is produced.
With trade, consumption in each country is expanded bcs world production is expanded when
each country specializes in producing the good in which it has a comparative ad.
A One Factor Ricardian Model
Model 2-2-1: 2 goods, 2 countries, 1 labor
 Assumption
1. Labor is the only resource important for production.
2. Labor productivity varies across countries, usually du to differences in technology, but labor
productivity in each country is constant across time.
3. The supply of labor in each country is constant.
4. Competition allows laborers to be paid a "competitive" wage, a function of their productivity
and the price of th good that they can sell, and allows laborers to work in the industry that pays
the highest wage.
5. Only two goods are important for production and consumption wine and cheese.
6. Only two countries are modeled: domestic and foreign.
 Denotations
- Labor productivity is constant
 a unit labor requirement = constant number of hours of labor required to produce 1 unit
of output
o 𝑎𝐿𝑊 is the unit labor requirement for wine in the domestic country
o 𝑎𝐿𝐶 is the unit labor requirement for cheese in the domestic country
- A high unit labor requirement means low labor productivity
- Because the supply if labor is constant, denote the total number of labor hours worked
in the domestic country as a company number L.

-
Production Possibilities
The production possibility frontier (PPF) of an economy shows the maximum amount of
a goods that can be produced for a fixed amount of resources.
o Qc represents the quantity of cheese produced
o Qw represents the quantity of wine produced
 PPF equation:
𝒂𝑳𝑪 𝑸𝑪 + 𝒂𝑳𝑾 𝑸𝑾 = 𝑳
𝑎𝐿𝐶 , 𝑎𝐿𝑊 : 𝐹𝑖𝑥𝑒𝑑 – Labor required for each unit of wine/cheese production
𝑄𝐶 , 𝑄𝑊 : 𝐶ℎ𝑎𝑛𝑔𝑒 – Total units of wine/cheese production
1 additional kg of cheese: aLC hours of work
Each hour devoted to cheese production could have been used to produce a certain amount of
wine instead, equal to:
1ℎ
1
=
(𝑙𝑖𝑡𝑒𝑟 𝑜𝑓 𝑤𝑖𝑛𝑒)
ℎ𝑜𝑢𝑟𝑠
𝑎
𝐿𝑊
𝑎𝐿𝑊 (
)
𝑙𝑖𝑡𝑒𝑟 𝑜𝑓 𝑤𝑖𝑛𝑒
𝑎
The trade-off is the increased amount of cheese relative to the decreased amount of wine 𝑎 𝐿𝐶
 opportunity cost of producing cheese
Exercise:
𝐿𝑊
There are two countries, Vietnam and Indonesia. Suppose each country can produce two goods,
apples (A) and bananas (B). Furthermore, suppose that Vietnam has 1000 working hours, while
Indonesia has 1500 working hours. Labor productivities in each country are given by the
following table:
Vietnam
8 apples/hour
2 bananas/hour
Apples
Bananas
Indo
3 apples/hour
6 bananas/hour
1. Which country has the absolute advantage in apples? in bananas?
Vietnam has absolute advantage in apples at 1/8h per unit < 1/3
Indo has absolute advantage in bananas at 1/6h per unit < ½
Vietnam
1/8h an apple
1/2h a banana
Apples
Bananas
-
Indo
1/3h an apple
1/6h a banana
Relative price:
In VN, 1h = 8a = 2b => A = 1/4B
Indo: 1h = 3a = 6b => A = 2B
2. In which good does Vietnam have a comparative advantage? In which good does
Indonesia have a comparative advantage?
Comparative advantages:
- In Vietnam, 1A = 2B
In Indonesia, 1A = 1/2B
 Vietnam has comparative advantage in apple
Indo has comparative advantage in banana
3. Derive and sketch the production possibility frontier (PPF) for each country.
Bananas
Bananas
8000
2000
8000
Apples
4500
Indonesia
Apples
Vietnam
- PPF
1
1
VN: 8000 apples/2000 bananas  8 ∗ 𝑄𝐴(𝑉𝑁) + 2 ∗ 𝑄𝐴(𝑉𝑁) = 1000
1
1
Indo: 4500 apples/8000 banana  3 ∗ 𝑄𝐴(𝐼𝑛) + 6 ∗ 𝑄𝐴(𝐼𝑛) = 1500
4. Assume that in autarky, Vietnam and Indonesia consume equal of apples that is 3000.
Find autarky equilibrium for each country. Show this graphically.
A in both countries = 3000
 In VN: Apples = 3000, Bananas = 1250
 In Indo: Apples = 3000, Bananas = 3000
-
Relative price:
In VN, 1h = 8a = 2b => A = 1/4B
Indo: 1h = 3a = 6b => A = 2B
𝑃
1
𝑃
𝑃
𝑏
𝑏
In autarky, (𝑃𝑎 )𝑉𝑁 = 4 < (𝑃𝑎 )𝑤 < (𝑃𝑎 )𝐼𝑛𝑑𝑜 = 2
𝑏
Autarky
Specialization
After trade
Gain from trade
Apple
3000
8000
4000
VN
Banana
1250
0
4000
Apple
3000
0
4000
Indo
Banana
3000
9000
5000
5. If international trade is opened up, what are the limits for the equilibrium
international price ratio?
VN
3000a, 1250b
Domestic Production n
Consumption
Full specialization
8000a, 0b
(production)
Domestice Consumption after D(50c, 175m)
Trade (1 đổi 3,5)
Gains from Trade
+25m
Indo
3000a, 3000b
0a, 9000b
D’(50c, 125m)
+10c, +25m
6. In free trade equilibrium, assuming price ratio is one apple worth one banana.
Assuming Vietnam and Indonesia consume equal amount of apples that is 4000. Show
production point, consumption point and gains from trade with free trade. Show this
graphically. Indicate trade triangle for each country.
USA: In autarky (Pcomp/Pcloth)US = 3
(3) Trade at the ratio 1c = 4m -> (ToT)US = 4
(4) Trade at the ratio 1c = 3,5m -> (ToT)US = 3.5
Gains from trade (1) > (2)
India: In autarky (Pcloth/Pcomp)US = 1/5
(3) Trade at the ratio 1c = 4m -> (ToT)US = 1/4
(4) Trade at the ratio 1c = 3,5m -> (ToT)US = 1/3.5
Gains from trade (1) > (2)
Production, Prices & Wages
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In general, the amount of the domestic economy’s production in defined by:
aLC QC + aLW QW < L
This describes what an economy can produce, but to determine what the economy does
produce, we must determine the price of goods.
Unit labor requirement
Wine
aLW (ℎ𝑜𝑢𝑟/𝑙𝑖𝑡𝑒𝑟)
Unit price of goods
𝑃LW (ℎ𝑜𝑢𝑟/𝑙𝑖𝑡𝑒𝑟)
Cheese
aLC (ℎ𝑜𝑢𝑟/𝑙𝑖𝑡𝑒𝑟)
Hourly wage
Price = Cost of production
1 liter of wine: aLW (ℎ𝑜𝑢𝑟𝑠) − PW ($)
aLW hours of work – PW
P
1 hour of work – a W
LW
A relative price is the rice a good or service in terms of another; i.e... the ratio of two prices
P
A relative price may be expressed in terms of a ratio between any two prices Pr = Px , or
y
The ratio between the price of one particular good and a weighted average of all other goods
P
available in the market P x
aog
Wage if Wine industry is higher it:
PW
PC
PW aLW
>
<=>
>
aLW
aLC
PC
aLC
Relative price
of Cheese
Opportunity cost of
Cheese Production
PW aLW
>
PC
aLC
The economy will specialize in Wine productions if the price of Wine
relative to the price of Cheese exceeds the oppor cost of producing Wine.
PC
aLC
>
PW aLW
The economy will specialize in Cheese productions if the price of Wine
relative to the price of Wine exceeds the oppor cost of producing Cheese.
PW aLW
>
PC
aLC
If the domestic country wants to consume BOTH wine and cheese (in the
absence of international wage
Workers will have no incentive to flock to either the cheese
industry or the wine industry  maintaining a positive amount
of production of both goods.
Production (and consumption)
Labor requirement to produce 1
liter of wine (hours of work)
Labor requirement to produce 1
liter of wine (hours of work)
Total number of labor hours
(hours of work)
Home
Foreign
aLW
a′LW
aLC
a′LC
L
L*
Home has absolute advantages in all production:
aLW < a′LW
aLC < a′LC
Home has comparative advantages in cheese production:
aLC
a′LC
<
aLW
a′LW
When Home increase cheese production
Bananas
L=
8000
2000
8000
Home
Apples
4500
Foreign
Apples
The differences in the Relative Prices of Goods or in the Opportunity Costs of Producing
Goods in the 2 Countries (illustrated by the slopes of their PPFs) reflect their Comparative
Advantages and provide the basis for International Trade.
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-
Even if a country is the most (or least) efficient producer of all goods, it still can benefit
from trade.
To see how all countries can benefit from trade, we calculate relative prices when trade
exists.
o Without trade, relative price of a good equals the opportunity cost of producing
that good.
To calculate relative prices with trade, we first calculate relative quantities of WORLD
production: (Qc + Q'c)/(Qw + Q'w)
Next we consider relative supply of cheese: the quantity of cheese supplied by all
countries relative to the quantity of wine supplied by all countries at each Pc/Pw
- After that we consider relative demand of cheese: the quantity of cheese
demanded by all countries relative to the quantity of wine demanded by all
countries at each Pc/Pw
• Relative supply curve & relative demand curve ->
World relative prices when trade exist
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