this slide explain about Foundations of Modern Trade Theory. this topic taken from international economics book by Robert J. Carbaugh.

1. International Economics
By Robert J. Carbaugh
8th Edition
Chapter 2:
Foundations of Modern Trade
Theory

2. Historical development of trade
theory
 Mercantilism
 positive trade balance
 Absolute advantage (Adam Smith)
 Countries benefit from exporting what they
make cheaper than anyone else
 Comparative advantage (David Ricardo)
 Nations can gain from specialization, even
if they lack an absolute advantage
Foundations of trade theory

3. Absolute & Comparative
Advantage
Comparative advantage
Absolute advantage: each nation is more efficient in
producing one good
Output per labor hour
Nation Wine Cloth
United States 5 bottles 20 yards
United Kingdom 15 bottles 10 yards
Comparative advantage: the US has an absolute
advantage in both goods
Output per labor hour
Nation Wine Cloth
United States 40 bottles 40 yards
United Kingdom 20 bottles 10 yards

4. Ricardo’s Comparative Advantage in
money prices
Comparative advantage
Cloth (yards) Wine (bottles)
Nation Labor Wage Quant. Price Quant. Price
US 1 hr $20/hr 40 $0.50 40 $0.50
UK 1 hr £5/hr 10 £0.50 20 £0.25
UK 1 hr $8 10 $0.80 20 $0.40
(at $1.6 = £1)

5. Production possibilities
schedule
 Generalizes theory to include all factors, not
just labor
 Shows combinations of products that can be
made if all factors are used efficiently
 Slope, or marginal rate of transformation,
shows the opportunity cost of making more
of one good (how much of one good must be
given up to make more of another)
Comparative advantage

6. Marginal Rate of
Transformation
Comparative advantage

7. Production possibilities schedules:
constant opportunity costs
Comparative advantage

8. Supply schedules: constant
opportunity costs
Comparative advantage

9. Trading under constant opportunity
costs
Comparative advantage

10. Production gains from
specialization: constant opportunity
costs
Comparative advantage
Autos Wheat Autos Wheat Autos Wheat
US 40 40 120 0 80 -40
Canada 40 80 0 160 -40 80
World 80 120 120 160 40 40
Before After Net Gain
Specialization Specialization (Loss)

11. Consumption gains from trade:
constant opportunity costs
Comparative advantage
Autos Wheat Autos Wheat Autos Wheat
US 40 40 60 60 20 20
Canada 40 80 60 100 20 20
World 80 120 120 160 40 40
Before After Net Gain
Trade Trade (Loss)

12. Complete specialization under
constant opportunity costs
Comparative advantage

13. Changing comparative
advantage
Comparative advantage

14. Trade restrictions and gains from
trade
Comparative advantage

15. Production possibilities schedule
under increasing costs
Increasing opportunity costs

16. Supply schedule under
increasing costs
Increasing opportunity costs

17. Trading under increasing costs: US
Increasing opportunity costs

18. Trading under increasing costs:
Canada
Increasing opportunity costs

19. Production gains from specialization:
increasing opportunity costs
Autos Wheat Autos Wheat Autos Wheat
US 5 18 12 14 7 -4
Canada 17 6 13 13 -4 7
World 22 24 25 26 3 3
Before After Net Gain
Specialization Specialization (Loss)
Increasing opportunity costs

20. Consumption gains from trade:
increasing opportunity costs
Autos Wheat Autos Wheat Autos Wheat
US 5 18 5 21 0 3
Canada 17 6 20 6 3 0
World 22 24 25 27 3 3
Before After Net Gain
Trade Trade (Loss)
Increasing opportunity costs