Comparative Advantage and Trade Comparative Advantage Between Nations

Comparative Advantage and Trade

Comparative Advantage Between Nations: Apple Island vs Wheat Island (WI), inhabited by Wheaties Apple Island (AI), inhabited by Apploids Production if 100% of island resources used on one good; Tradeoffs when both are produced 12. 5 K apples or 10 K tons of wheat; 1. 25 apples per ton of wheat 0. 8 tons of wheat per apple 10 K apples or 4 K tons of wheat; 2. 5 apples per ton of wheat 0. 4 tons of wheat per apple Comparative Advantage Wheat Apples

Feasible Production Sets in Autarky Apple Island (AI), inhabited by Apploids Wheat Island (WI), inhabited by Wheaties 10, 000 Tons of wheat Slope = -0. 8 tons wheat per apple Wheaties feasible set Slope = -0. 4 tons wheat per apple 4, 000 Apploids feasible set Number of apples 12, 500 Number of apples 10, 000

Production and Consumption in Autarky Wheat Island (WI), inhabited by Wheaties Apple Island (AI), inhabited by Apploids 10, 000 Tons of wheat E Wheaties’ indifference curves Tons of wheat 6, 000 10, 000 4, 000 2, 500 5, 000 Number of apples 12, 500 Apploids’ indifference curves D 3, 750 10, 000 Number of apples

Production and Consumption Choices in Autarky price of apples in terms of wheat: 10, 000 – WI: 0. 8 tons of wheat – AI: 0. 4 tons of wheat – Apples more expensive on WI. – AI will specialize in apples and WI in wheat. – What would be the world price of apples? – Hint: AI/WI will only export if it can get wheat/apples more cheaply than if it produced it itself. Wheaties’ indifference curves Tons of wheat If WI and AI were to trade without cost (i. e. no price gap): Wheaties’ feasible consumption frontier E 6, 000 4, 000 D 2, 500 Apploids’ indifference curves 3, 750 5, 000 Apploids’ feasible consumption frontier 10, 000 12, 500 Number of apples

From Autarky to Trade • E and D are consumption in autarky. 10, 000 – World production is 8. 5 K tons of wheat and 8. 75 K apples. – World production is 10 K apples and 10 K tons wheat. – Price of apples is between 0. 4 and 0. 8. • Apples cheaper than autarky in WI and more expensive in AI. • Wheat cheaper than autarky in AI and more expensive in WI. – Both AI and WI reach higher indifference curves. Tons of wheat • With costless trade, 8, 000 A Wheaties’ feasible consumption frontier (through trade) Apploids’ feasible consumption frontier (through trade) E 6, 000 5, 000 4, 000 2, 500 2, 000 Apploids’ feasible production frontier D Wheaties feasible production frontier B 4, 000 5, 0006, 000 3, 750 10, 000 12, 500 Number of apples

Comparative Advantage and Trade • With trade, AI specializes in producing apples and WI specializes in producing wheat. • Both of their consumption frontiers are above their production frontiers, so they are both better off. The relative price of apples to wheat depends on each countries’s bargaining power and reservation option.

Winners and Losers: Short Run Opening trade increases countries’ consumption possibility sets, but conflicts of interest emerge between and within countries. Hecksher-Ohlin model suggests winners and losers from trade depend on the relative scarcity of factors e. g. skilled labor, unskilled labor, capital, land: • Relatively abundant factors within a country are relatively cheap, and gain when trade raises their price towards the world average. • Conversely, the price of relatively scarce factors falls towards the world average due to trade. • Note: price of labor is the wage; price of land is land rent; price of capital is the return to capital.