ABSOLUTEADVANTAGE THEORY
• NUMBER OF LABOR HOURS NEEDED
TO PRODUCE ONE UNIT OF
SOYBEANS TEXTILES
U.S.
5
15
20
ENGLAND
20
5
25
ABSOLUTEADVANTAGE THEORY
•
NUMBER OF LABOR HOURS NEEDED TO PRODUCE ONE UNIT OF
SOYBEANS
EXTILES
U.S.
5
15
ENGLAND
20
5
• relative prices (domestic Terms Of Trade,
TOT, before international Trade):
• In U.S.
[5/15] or 1 T= 3 S
• In England [20/5] or 4 T = 1 S
ABSOLUTEADVANTAGE THEORY
Production Before International Trade (Autarky)
Soybeans
U.S.
1
England
1
Total
2
Textiles
2
1
1
4
Total
2
2
ABSOLUTEADVANTAGE THEORY
Allocation of Labor after specialization
• U.S.
• ENGLAND
SOYBEANS
TEXTILES
20
0
0
25
ABSOLUTEADVANTAGE THEORY
Production After Specialization
Soybeans
• U.S.
4
• England
0
• Total
Textiles Total
0
4
5
5
9
ABSOLUTEADVANTAGE THEORY
Assume that term of trade is established to be one
to one
Consumption After International Trade
Soybeans Textiles Total
• U.S.
• England
3
1
1
4
4
5
9
Comparative Advantage THEORY
What if one country has absolute advantage in the
production of both commodities ?
NUMBER OF LABOR HOURS NEEDED TO
PRODUCE ONE UNIT OF
• US
• ENGLAND
SOYBEANS
5
10
TEXTILES
15
20
Comparative Advantage THEORY
relative prices Before international Trade
• U.S.
• England
1T /3S
1T /2S
Comparative Advantage THEORY
Production Before International Trade
Soybeans Textiles
• U.S.
1
1
• England 1
1
Total
2
2
4
Comparative Advantage THEORY
U.S. advantage over England are:
• Soybeans
5/10 = 1/2 = 3/6
• Textiles
15/20 = 3/4
U.S. has a higher advantage in both S and T relative to
England.
The question is which one should the US specialize
in?
Comparative Advantage THEORY
U.S. advantage over England are:
• Soybeans
• Textiles
5/10 = 1/2 = 3/6
15/20 = 3/4
But US's advantage is higher in S. Why?
Comparative Advantage THEORY
U.S. advantage over England are:
• Soybeans
5/10 = 1/2 = 3/6
• Textiles
15/20 = 3/4
But US's advantage is higher in S. Why?
This is because there is a relatively smaller labor
requirement for the production of S than for the
production of T.
Comparative Advantage THEORY
U.S. advantage over England are:
• Soybeans
5/10 = 1/2 = 3/6
• Textiles
15/20 = 3/4
But US's advantage is higher in S. Why?
This is because there is a relatively smaller labor requirement for the production of S than for the
So, even though the united States has an
absolute advantage in the production of S and T,
there is a higher advantage in the production of S.
Therefore US must specialize in the production of S
and England must specialize in the production of T
in which she has a smaller disadvantage.
production of T.
Trade Triangle
Assume that the United States and England
specialized in S and T respectively. Then the pattern
of production and, consumption, exports, and
imports would be:
Trade Triangle
• BCD and B’C’D’ are equal. That is exports pay for
imports.
T
T
D’
B
O
C
C’
D
S
O’
B’
S
Trade Triangle
•
production consumption
US
OD
(S) OC
(T) BC
exports
CD
imports
BC
UK
•
C'D'
B'C'
O'D'
(S) O'C'
(T) B'C'
Evaluation of the Classical Model
1-- International trade
• expands PPC
• enhances standard of living for countries
involved
Evaluation of the Classical Model
2-- Problems:
• it suggests that international trade is based
on the productive capacities of different
countries but it does not explain why they
exist.
Evaluation of the Classical Model
2-- Problems:
• it suggests that international trade is based on the productive capacities of
different countries but it does not explain why they exist.
• It makes extreme predications about
direction of trade and specialization which
are not borne out in the real world.
Evaluation of the Classical Model
2-- Problems:
• it suggests that international trade is based on the productive capacities of
different countries but it does not explain why they exist.
• It makes extreme predications about direction of trade and specialization
which are not borne out in the real world.
• The theory predicts that the greatest gain
from trade come about when the countries
involved are very dissimilar in their
technologies. However, we know that most
of the international trade is among advanced
countries with similar technologies.