chapter 14: Comparative Advantage and the Gains from Trade Flashcards
The term defining the improvement in national welfare
gains from trade
mercantilism
term that Adam Smith roasted
the system of nationalistic economics that dominated economic thought in the 1700s
stressed exports over imports, primarily as a way to obtain revenues for building armies and national construction projects
The key mistake in mercantilist thinking
the belief that trade was a zero sum activity
zero sum activity
one wins, the other loses
Ricardian model assumptions
there are only two countries, producing two goods, using one input (labor)
firms are price takers, or, in other words, markets are competitive, and no firm has market power
technology is constant and there are no learning effects of production that might make firms and industries more productive over time
labor is perfectly mobile between industries but perfectly immobile across national borders
productivity in the Ricardian model
the amount of output obtained from a unit of input
labor productivity
(units of output)/(hours worked)
absolute productivity advantage
producing more of a good with the same amount of input than other countries
opportunity cost of productivity
what you could have produced of another good in units instead of what you actually produced
static gains from trade
gains from trade opening that occur immediately
dynamic gains from trade
gains from trade opening that occur over time
why are dynamic gains from trade difficult to predict?
they depend on changes in innovation and productivity
why is it hard to measure gains from trade?
static gains from trade and dynamic gains from trade
all countries already trade, so most of what is measured are the potential gains from some additional amount of trade and not the benefits or gains that a country currently has from participating in trade
production possibilities curve (PPC)
shows the trade-offs a country faces when it chooses its combination of different products
what is the slope of a straight production possibilities curve (PPC)?
the opportunity cost of giving up one product for another
relative price
it is not in monetary units, but rather in units of the other good
the relative price of a good must be equal to its opportunity cost in production
The term that defines the complete absence of trade
autarky
in an autarky, to what is consumption limited to?
to the goods that are produced at home
consumption possibilities curve (CPC)
defined by the going relative price of a good
shows different levels that a good is worth of another good
pre trade, what is the level of consumption available?
the point which at which the PPC and CPC meet
in the absence of trade, consumption must equal production
what is the effect of specializing on the CPC
how does it do this?
the CPC moves to the right since now you have much more goods available to consume
it maximizes the producing country’s income
Absolute productivity advantage
defined as having higher labor productivity
when does a country have a comparative productivity advantage in a good?
if its opportunity costs of producing a good are lower than those of its trading partners
what is more important in trade:
absolute advantage or comparative advantage?
comparative advantage
is making policies that enrich corporations and make them more efficient always the best allocation of a nation’s resources?
nah
ex: Indonesia and airplanes
what is a mistake that is often made regarding comparative advantage of nations with other nations?
why is it a mistake?
the mistake is that some people want nations to act as business
nations do not compete with each other in any normal sense of the word
Economic relations between any pair of nations are not equivalent to the commercial competition that exists between companies such as Coke and Pepsi
Economic restructuring
changes in the economy that may require some industries to grow and others to shrink or disappear altogether
does opening trade always benefit every individual?
why or why not?
nah boy
often requires stopping or reducing an industry in the country
opening an economy to increased foreign competition is rarely painless and usually generates a number of new problems
some laid-off workers in a declining industry may quickly find new jobs, many do not
what is the reasoning behind the people that believe that the government SHOULD NOT do anything to help losers of trade?
argue that government should not have any policies for handling unemployment caused by the rapid growth of imports
unemployment is a self-correcting problem; laid-off workers will look for new jobs and will, if necessary, accept lower wages
what is the reasoning behind the people that believe that the government SHOULD do anything to help losers of trade?
the nation as a whole benefits from trade, so there are newly added resources to the economy that make compensation possible
many people believe that they have an ethical obligation to assist people hurt by economic change
compensation reduces the incentives to oppose foreign trade
trade adjustment assistance (TAA)
these programs take the form of extended unemployment benefits and worker re-training
ex: NAFTA
how to qualify to the trade adjustment assistance (TAA) NAFTA?
workers must demonstrate that they were laid off as a result of imports from Mexico or Canada or because their firm relocated to one of those countries
The single most important determinant of trade patterns
the opportunity cost of producing traded goods
Countries that sacrifice the least amount of alternative production when producing a particular good have the highest or lowest opportunity cost?
lowest opportunity cost
Countries that sacrifice the least amount of alternative production when producing a particular good have or don’t have a comparative advantage?
do have one
how do countries maximize the benefits they receive from trade and, consequently, their national welfare?
Nations that produce according to their comparative advantage
is it necessary to have an absolute advantage in order to have a comparative advantage?
nah
