Chapter 3 Flashcards
Who introduced the law of comparative advantage
David Ricardo
The law of comparative advantage states that there is still a basis for mutually beneficial trade even if
A nation has absolute disadvantage with respect to other nation in production of both commodities
According to the law of comparative advantage, the first nation (has absolute disadvantage in both commodities) should specialize in the production and export of
the commodity of its ______________
Comparative advantage
A nation with absolute disadvantage in both commodities, it should import the commodity of its ______________
comparative disadvantage
Ricardo’s assumptions are
- No international mobility of factors but free mobility within the nation
- Two-nation, two-good world
- Perfect competition in both factor and commodities markets
- No transportation costs
- Labor theory of value
- No trade restrictions
If the Uk relative production of wheat to the US is 1 : 6 and the relative production of cloth to the US is 2 : 4 then the UK has a comparative advantage in
Cloth
If the Uk relative production of wheat to the US is 1 : 6 and the relative production of cloth to the US is 2 : 4 then the UK has absolute disadvantage in
Both commodities
According to the law of comparative advantage, how both nations can gain
Both nations can gain if the US specializes in the production of wheat (its comparative advantage) and export it and import cloth from the UK while the UK
is specializing in the production of cloth (its comparative advantage) and importing wheat from the US
According to the law of comparative advantage, if the international exchange rate is 6w:6c then for the US which have a domestic exchange rate of 6:4 if it traded internationally it would gain ( knowing that trade will take place)
2C or save 1/2 hour of labor time, since the United States could only exchange 6W for 4C domestically
According to the law of comparative advantage, if the international exchange rate is 6w:6c then for the UK which have a domestic exchange rate of 1:2 if it spent 6 hours in producing cloth then, the
UK would gain
6C or save three hours of labor time
An example where there is no comparative advantage can be
US’s wheat : UK’s wheat
6 : 3
US’s cloth. : UK ‘s cloth
4. : 2
How to determine if comparative advantage is the basis of trade
By looking at relative productivity
What is the relative labour productivity of the following ratios:
Labour productivity UK : US
Wheat 4 12
Cloth 1 3
Labour productivity UK : US
Wheat 4/12= 1/3 12/4=3
Cloth 1/3 3/1=3
Why in this case trade doesn’t take place:
Labour productivity UK : US
Wheat 4/12= 1/3 12/4=3
Cloth 1/3 3/1=3
Because absolute disadvantage that the UK has with respect to the US is in the same proportion for the two commodities
The modified statement of the law of comparative advantage is
Even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still basis for mutually beneficial trade, unless the absolute disadvantage is in the same proportion for the two commodities.
