INTERNATIONAL

TRADE

at the end of the lesson you should

be able to:
explain meaning of absolute
advantage
explain meaning of comparative
advantage
distinguish between absolute and
comparative advantage
calculate opp.cost ratio
identify absolute advantage and
comparative advantage graphically
explain gains from trade using the

Assumptions:

2 model country : X and Y

2 goods produced wheat and cloth
There are no barriers to trade (no
tariffs etc), no transportation cost
Perfect mobility of resources: of
one
industry can be switched into
another
without any loss of efficiency
Constant returns to scale (i.e.
doubling
the inputs in each country leads to a
doubling of total output)
Both countries have equal resources
which are divided equally between
the 2

Theory of
absolute
advantage

absolute advantage
A country is said to have absolute
advantage in the production of a
good when it can produce the
good more efficiently than other
countries. Either it produces more
by using the same resources or uses
fewer resources to produce the same
quantity as others i.e. produces it
cheaper

Production before specialisation

Country

Wheat in
tonnes

Cloth in
metres

10,000

5,000

5,000

10,000

World
output

15,000

15,000

absolute advantage
X has absolute advantage in ______
and therefore specialises in _____
production
Y has absolute advantage in ______
and therefore specialises in _____
production

Production after specialisation

Country

Wheat in
tonnes

Cloth in
metres

20,000

World output

Production before specialisation

Country
X

Wheat in tonnes Cloth in metres

20,000
-

20,000

World output

20,000

20,000

Total Gain

Production after specialisation

Country

Wheat in tonnes Cloth in metres

20,000

20,000

World output

20,000

20,000

Total Gain

5000

5000

Theory of
Comparative
advantage

comparative advantage
Comparative advantage
exists when a country has a
margin of superiority in the
production of a good or
service i.e. where the
opportunity cost of
production is lower.

Production before specialisation

Country

Wheat in
tonnes

Cloth in
metres

10,000

5,000

4,000

4,000

World
output

14,000

9,000

comparative advantage

wheat

20,000

Y
8,000

Y
0

8,000

X
10,000

cloth

opportunity cost of production

Country

Opportunity
cost of 1 wheat

*give up = 5000
get 10,000

*For input method, o.c = __get__

give up

Opportunity
cost of 1 cloth

opportunity cost of production

Country

Opportunity
cost of 1
wheat

Opportunity
cost of 1
cloth

0.5

O.C of wheat
production

to produce 1
wheat , X gives
up 0.5 cloth
to produce 1
wheat , Y gives
up 1 cloth

O.C of wheat
production

Since ___ produces

wheat at a less
opportunity cost,
it has a ________
advantage in
wheat, it
specialises in _____

O.C of cloth
production

to produce 1
cloth , X gives
up __ wheat
to produce 1
cloth, Y gives up
__ wheat

O.C of wheat
production

Since ___ produces

cloth at a less
opportunity cost,
it has a ________
advantage in
cloth, it
specialises in _____

Production after specialisation

Country

Wheat in
tonnes

Cloth in
metres

World
output

Domestic O.C ratios

Wheat : Cloth
X=
2W : 1C
Y=
1W : 1C
* Terms of exchange or
exchange ratio should lie
between the two o.c. ratios
assume exchange ratio = 1.5W: 1C
means X exchanges1.5w for 1c
Y exchanges 1c for 1.5w

Gains from trade

Before specialisation,
X gives up 2 wheat to get
1 cloth
After specialisation,
X gives up 1.5 wheat to
get
1 cloth
X gains by giving up
less than before.

win-win situation
Before specialisation,
Y gets 1 wheat for 1
cloth
After specialisation, Y
gets 1.5 wheat for 1
cloth
Y gains by getting
more than before.

Consumption Possibility Curve

Specialisation and trade
therefore allows an

economy to
consume
beyond its PPC