Chapter 17 - The Gains from International Trade Flashcards
What is comparative advantage?
When a country can produce a good at a lower opportunity cost than another.
What is absolute advantage?
When a country can produce more of a good using fewer resources than another.
How do countries benefit from trade?
By specializing in goods with the lowest opportunity cost and trading for others, countries can consume beyond their production possibilities.
What is the law of one price?
In efficient markets, identical goods should sell for the same price worldwide (adjusted for transport and taxes).
When does Canada export a good?
When the world price > domestic price, indicating a comparative advantage.
When does Canada import a good?
When the world price < domestic price, indicating a comparative disadvantage.
What is the formula for the Terms of Trade (ToT)?
ToT = (Export Price Index / Import Price Index) × 100
↑ ToT = improved welfare (more imports per unit of exports)
↓ ToT = decline in purchasing power
What are the sources of comparative advantage?
Natural factors (e.g. land, climate)
Human capital (skills, education)
Acquired advantages (innovation, policy)
Factor endowments (per Heckscher-Ohlin theory)
What is intra-industry trade?
Trade between countries in similar goods (e.g., cars for cars), driven by product variety and economies of scale.
How does specialization improve efficiency?
Specialization allows for economies of scale and learning by doing, reducing costs and increasing output.
What does the slope of a production possibilities boundary (PPB) reflect?
Opportunity cost of one good in terms of the other.
What are global supply chains and how do they affect trade?
Products are now made in stages across many countries. Comparative advantage applies to specific tasks rather than whole products.
What happens when trade occurs with fixed production?
Countries consume beyond their original PPB by exporting some goods and importing others.
What happens when trade changes production patterns?
Countries reallocate resources to specialize further, shifting production toward goods they can export efficiently.
What determines the pattern of international trade?
Differences in domestic vs. world prices due to comparative advantage and opportunity cost.
Country A can produce 10 wheat or 5 cloth.
Country B can produce 6 wheat or 3 cloth.
Q: Who has the comparative advantage in wheat?
A: Country B (lower opportunity cost: 1 cloth = 2 wheat vs. Country A’s 1 cloth = 2 wheat → tie, so check the other good).
If Brazil can produce 1 car or 100 bananas, and Ecuador can produce 1 car or 50 bananas…
Q: Who should specialize in banana production?
A: Brazil. Brazil gives up fewer cars per banana (1 car = 100 bananas → 1 banana = 0.01 cars vs. Ecuador’s 0.02).
Q: If the opportunity cost of 1kg of chocolate in Austria is 1/80 glass and in Switzerland it’s 1/50 glass, who should specialize in chocolate?
A: Austria — lower opportunity cost means comparative advantage in chocolate.
Canada can make 100 lumber or 20 computers.
The US can make 80 lumber or 40 computers.
Q: Who has the comparative advantage in lumber?
A: Canada:
Canada’s OC = 1 lumber = 0.2 computers
US OC = 1 lumber = 0.5 computers
→ Lower opportunity cost = Canada
If Chile gives up 3 grapes to make 1 fish, and Norway gives up 2 grapes to make 1 fish…
Q: Who has the comparative advantage in fish?
A: Norway (lower opportunity cost = better at producing fish).
Why can two countries still benefit from trade even if one has an absolute advantage in everything?
Because comparative advantage is based on opportunity cost, not absolute productivity.
