Chapter 3 Comparative Advantage and Factor ProportionsLink to syllabusChapter 3. Comparative advantage –why countries can gain fromtrade, and who will trade which product.Questionable examplepage 36.Book’s example. My example. PPcurve. Opportunity cost.Demonstration of who has comp. adv.Demonstration of gains from trade.Adam Smith: The Wealth of Nations1776In a free market society,individuals, acting out of their ownself interest, will be guided, as if byan invisible hand, to make sociallybeneficial economic decisions.Also: benefits of free trade, criticism ofmercantilism.Adam Smith: Individuals acting out of their own self interest, will be guided, as if by an invisible hand, to make socially beneficial economic decisions.Also, benefits of free trade, and criticism of mercantilism.David Ricardo. 1772-1823Born in London; father was a stockbroker.In addition to major contributions inEconomics, he was a member of the BritishParliament, a businessman and financier.Said to have become interested in economicsat the age of 27, after reading Adam Smith,while on vacation. Was friends with James Mill, Bentham, Malthus, and other classical economists.David Ricardo. 1772-1823Born in London; father was a strockbroker.In addition to major contributions inEconomics, was a member of the BritishParliament, a businessman and financier.Saidto have become interested in econat the age of 27, after reading Adam Smith,while on vacation. Was friends with James Mill, Bentham, Malthus, and other classical economists.Smith talked about benefits of trade, using argument of absolute advantage. Argued against mercantilism.Mercantilism: trade is source of growth (through exports). Imports were to be minimized. Emphasis on generating employment. Accumulate gold (balance of payments surplus). Book states that mercantilists viewed trade is a zero sum game.Ricardo: labor theory of value. Comp. advantage.Book’s exampleof Ricardian model(p. 37):
2Labor hours to make one unit ofU.S. R.o.W.Cloth 4.0 1.0Wheat 2.0 1.5Labor Productivity (units of cloth per hour): [inverse of labor hoursUS R.o.w.Cloth/labor .25 1.0Wheat/labor 0.5 0.66Ricardian example of comparative advantage. Page 37 Pre-trade Prices, in Ricardo’s Example p. 38Ricardian model of comparative advantage.Data on Page 36.Typos for R.o.W.Also, question of notation on p. 38R.o.W. has absolute advantage in both goods. Maybe US would fear trade in either good.Let’s look at comparative advantage. Where are goods relatively cheaper? Calculation of opportunity costs:In U.S., one unit of cloth requires 4 units of labor, which could have produced 2 units of wheat. So the opportunity cost of cloth in terms of wheat in the US is 2.In R.o.W., one unit of cloth requires 1 unit of labor which could have produced 2/3 unit of wheat. So cloth’s opportunity cost in terms of wheat in R.o.W. is 2/3. It is cheaper there.Pre-trade Relative prices:U.S. R.o.W.Pcl/Pwh 2bu/yard 0.67 bu/yard