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Introduction Classical economics and comparative advantage Analysis of comparative advantage

International Trade & the World Economy;  Charles van Marrewijk. CHAPTER 3; COMPARATIVE ADVANTAGE. Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade

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Introduction Classical economics and comparative advantage Analysis of comparative advantage

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  1. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  2. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  3. International Trade & the World Economy;  Charles van Marrewijk Introduction David Ricardo (1772-1823)

  4. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  5. International Trade & the World Economy;  Charles van Marrewijk Classical economics and comparative advantage Technological differences between nations are the classical driving force behind international trade flows. According to David Ricardo relative or comparative differences are important, not absolute differences. According to Paul Samuelson (1915-; Nobel prize 1970) the theory of comparative advantage is One of the few ideas in economics that is true without being obvious The idea of comparative advantage is often misunderstood, see Paul Krugman (1953-) “Ricardo’s difficult idea” at http://web.mit.edu/krugman/www

  6. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  7. International Trade & the World Economy;  Charles van Marrewijk unit labor requirement = units of labor required to produce one unit of a final good By assumption this is independent of the number of laborers active in a sector (CRS), but may differ between the two countries. Analysis of comparative advantage International trade based on differences in technology assumptions • 2 countries; EU and Kenya • 2 goods; Food and Chemicals • 1 factor of production; labor L • Constant returns to scale; CRS • Labor mobility between sectors, not between countries • Perfect competition • No transport costs Let be the for good F in EU, etc unit labor requirement

  8. International Trade & the World Economy;  Charles van Marrewijk Analysis of comparative advantage Productivity table to summarize the state of technology Note that the EU is more efficient than Kenya in the production of both goods, requiring 2 < 4 laborers for Food and 8 < 24 laborers for Chemicals. Why would the EU trade with Kenya? Note: EU is twice more productive in Food, and three times in Chem. In autarky (without international trade) both countries will produce both goods if consumers demand both Food and Chemicals.

  9. International Trade & the World Economy;  Charles van Marrewijk Conclusion: EU Kenya change world prod. production of chem. +1 -1 0 production of food -4 +6 +2 Analysis of comparative advantage According to David Ricardo both countries can gain from international trade through specialization (EU producing more chemicals and Kenya producing more food): Suppose Kenya produces 1 chemical less, this frees up 24 laborers. These 24 laborers can now produce 24/4 = 6 units of food To keep the production level of chemicals constant, the EU should make 1 chemical more. This requires 8 laborers. These 8 laborers could have made 8/2 = 4 units of food. The extra production represents gains from trade

  10. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  11. International Trade & the World Economy;  Charles van Marrewijk Production possibility frontier and autarky • Production possibility frontier (ppf) = All possible combinations of efficient production points given the available factors of production and the state of technology. Note: • ppf depends on available factors of production • ppf depends on state of technology • ppf does not depend on type of market competition

  12. International Trade & the World Economy;  Charles van Marrewijk Production possibility frontier and autarky Autarky prod. and cons. along ppf (determines autarky price ratio)

  13. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  14. International Trade & the World Economy;  Charles van Marrewijk Terms of trade and gains from trade Terms of trade is 4.8 food per unit of chemicals Both countries gain if international price is in between autarky prices

  15. International Trade & the World Economy;  Charles van Marrewijk Terms of trade and gains from trade Terms of trade is 4 food per unit of chemicals Only Kenya gains if international price is equal to EU autarky price

  16. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  17. International Trade & the World Economy;  Charles van Marrewijk Application: Kenya and the EU Not all exports behave in accordance with comparative advantage (but explains more trade flows than absolute advantage)

  18. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  19. International Trade & the World Economy;  Charles van Marrewijk More countries and world ppf If we identify more countries and two goods we can calculate individual ppf’s with a slope depending on comparative advantage. Combining these in a world ppf gives rise to a concave frontier (next slide)

  20. International Trade & the World Economy;  Charles van Marrewijk More countries and world ppf

  21. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  22. International Trade & the World Economy;  Charles van Marrewijk The Balassa index II The Ottens (2000) calculations of the Balassa index uses the OECD countries as reference. Sometimes all countries in the world are used. Hinloopen and van Marrewijk (2001) use data on EU exports for 98 sectors to Japan to calculate the Balassa index, such that: similar trade policy access to the Japanese for all countries similar development levels for the EU countries similar distance (physical and pecuniary costs) for all countries which supposedly results in a ‘cleaner’ measure of comparative advantage and the probability density function of the Balassa index as depicted on the next slide.

  23. International Trade & the World Economy;  Charles van Marrewijk The Balassa index II The probability density function of the Balassa-index based on monthly-moving annual observations (restricted to 0  BI  4) source: Hinloopen and van Marrewijk (2001)

  24. International Trade & the World Economy;  Charles van Marrewijk CHAPTER 3; COMPARATIVE ADVANTAGE Introduction Classical economics and comparative advantage Analysis of comparative advantage Production possibility frontier and autarky Terms of trade and gains from trade Application: Kenya and the EU More countries and world ppf The Balassa index II Conclusions

  25. International Trade & the World Economy;  Charles van Marrewijk Conclusions Technological differences between countries are the classical driving force for international trade flows. Only comparative costs, not absolute costs, are important for determining the direction of trade flows. Absolute costs are important for determining a country’s welfare level. Empirically, comparative costs performs somewhat better than absolute costs. Allowing for more countries and more goods is easy, allowing for more than one factor of production is not (see part II).

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