Concepts Affecting Trade <ul><li>Absolute advantage – exists when one nation can produce goods more cheaply than another nation. </li></ul><ul><li>Comparative advantage – ability of a nation to specialize in the production of the good for which it has the greatest comparative advantage or lowest opportunity cost. </li></ul><ul><li>Competitive advantage – economic competitive of a nation reflected in the absolute cost of a given good in a given market at a particular point in time. </li></ul>Pages 359-363
The U.S. is the most efficient producer of wheat while Mexico is the most efficient producer of coffee. With trade, the U.S. would specialize in wheat and exchange part of its surplus for coffee. Mexico would specialize in coffee and trade part of the surplus for wheat Page 360
Mexico has the absolute disadvantage in producing both goods because its productivity fell by 50% from the previous example). While the U.S. is more productive in both goods, its relative advantage is greatest in wheat (5.0>1.33). The U.S. therefore has a comparative advantage in wheat while Mexico has the least comparative disadvantage in coffee, or comparative advantage in coffee. Page 361
Factors Affecting Comparative Advantage…. <ul><li>National differences in opportunity costs </li></ul><ul><li>Costs affected by availability of resources </li></ul><ul><li>Costs affected by production requirements for goods and services produced </li></ul><ul><li>Costs affected by resource combinations </li></ul><ul><li>Costs affected by resource mobility </li></ul>Page 362
Page 364 Based upon assumption that both countries fully employ all resources, technology and specific amounts of labor per year.
Page 365 U.S produces 100 tons of wheat and 40 tons of coffee.
Page 365 U.S produces 100 tons of wheat and 40 tons of coffee. Mexico produces 32 tons of wheat and 12 tons of coffee
Page 366 Through trade, the U.S. specializes in wheat at point B, trades 50 tons of wheat to Mexico for 45 tons of coffee, and consumes more of both goods at point C (45 tons of coffee and 150 tons of wheat). By comparing point C with point A, we see that the U.S. has gained from trade.
Page 366 Mexico will specialize in coffee, producing 60 tons at point B’ and no wheat. They would trade 45 tons of coffee for 50 tons of wheat, and consumer more of both goods (50 tons of wheat and 15 tons of coffee at point C’) than it could at point A’.
Summary <ul><li>The law of comparative advantage was contrasted with absolute advantage and competitive advantage . </li></ul><ul><li>Trade occurs because traders anticipate gains from trading. </li></ul><ul><li>Comparative advantage determines why nations trade. </li></ul><ul><li>The basis for trade is differing opportunity costs among nations. </li></ul><ul><li>Nations specialize in producing those goods in which they are most efficient and exchange these goods with other nations. </li></ul>