Chapter 3 Flashcards
What did Adam Smith do?
Criticized mercantilism by bringing up comparative advantage
What were arguments against mercantilism?
Imports enable countries to live better
Non-zero sum - both sides gain
Trade barriers shrink the size of the market
Trade extends the market - specialization
What is a model of production and trade (Ricardian model)?
2 countries
2 goods produced
1 input - labour
We assume:
No market power
No tech changes
Constant returns to scale
No trade costs
All trade is barter
Firms are price takers
What is labor’s role in production and trade?
Labor is mobile between the 2 sectors of production
Labor is homogeneous
Labor is fully employed
Labor is immobile
What is productivity?
The amount of output per unit of input
What is labour productivity?
Output per unit of labor inputs
Units of output/hours worked
What is absolute productivity advantage?
Higher output per hour worked than a competitor - absolute advantage
What is an opportunity cost?
The value of the best alternative that is given up when a choice is made
What is autarky?
Self-sufficiency -> no trade
What are gains from trade?
The increase in goods available through trade vs what a country can produce itself
What is the PPC?
Shows tradeoffs between the 2 goods
Straight line since there is a constant tradeoff
- production inside PPC is inefficient
- production outside is impossible
- production along the curve is full employment
What does the slope of PPC tell you?
Slope is the opportunity cost of one product to another
It is the relative price of the good on the horizontal axis
What is the consumption possibilities curve?
Shows what a country can consume when it produces at a point on its PPC and trades
Slope is -(change)/(change)
Slope is the world (trade) price of steel
What is the difference between absolute and comparative advantage?
Absolute means a country has greater labour productivity
Comparative means a country has a lower opportunity cost
Trade is based on comparative
What does competitive advantage mean?
Selling at a lower cost
Lower opportunity costs
= comparative when markets are perfectly competitive and prices of all inputs and outputs reflect their relative scarcity
not = when prices do not reflect the relative scarcity
When is comparative advantage not competitive?
When prices do not reflect relative scarcity
- in trade, when government supplies protection or subsidies
- protection drives up the price of imports
- subsidies drives down private cost of production
Countries can be internationally competitive in industries where they do no have comparative advantage if they receive subsidies
How can a country with no absolute advantage still gain from trade?
Even if the opportunity cost is greater and higher productivity; it follows comparative advantage and specializes where its o.c. is lower
What is economic restructuring?
Changes in the economy that may require some industries to grow and others to disappear
