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Theory of Theory of comparative advantage David Ricardo
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Assumptions Two countries only: Two goods only: No transportation costs Country A and Country B and Cars Wine
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Before specialisation and trade : output produced per unit of resources
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Which country can produce more cars with the same amount of resources? Country A Which country can produce more wine with the same amount of resources? Also Country A
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Since the Country A is more productive in the production of both goods, it is said to possess an _________________ in the production of both goods. absolute advantage
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Suppose: Each country has 2 units of resources What are the production combinations of the two countries before trade?
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Production combinations before trade Total and 2522
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= 0.6 unit of wine = 1.6 units of cars Opportunity cost of 1 case of wine Opportunity cost of 1 unit of car Country A = 2 units of wine = 0.5 units of cars Country B Opportunity costs of production
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Country A has a _____ opportunity cost of producing cars than Country B. Country B has a _____ opportunity cost of producing wine than China. lower
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It means that a country can produce a good at a ____________________ than another country. lower opportunity cost What is comparative advantage?
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Country A has a comparative advantage in producing _________ and the Country B has a comparative advantage in producing ______. cars wine
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Suppose Country A specialises in producing cars and Country B specialises in producing wine. Output after specialisation What is the output combinations after specialisation? Suppose each country has 2 units of resources: Country A: uses 1 and a half units of resources to produce cars and half a unit of resource to produce wine ( partial specialisation ) Country B: uses all the resources to produce wine ( complete specialisation )
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Suppose Country A specialises in producing cars and Country B specialises in producing wine. Output after specialisation Total and 3026 What is the output combinations after specialisation?
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Principle of comparative advantage After specialisation, the output of both cars and wine are higher / lower. Principle of comparative advantage: Before specialisation After specialisation When countries specialise according to their comparative advantage( lower opportunity cost ), their _______________ will be maximised. combined output
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The gains from trade Suppose the terms of trade is 1unit of Car:1 unit of wine. Volume of trade : 9 units of cars and 9 cases of wine. What is the consumption combinations after trade? Total and 3026
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The gains from trade After trade Before trade
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=(1 – 0.6) wine=( 1 -0.5)car The gains from trade Country A:1 unit of car exported Suppose the terms of trade is 1 Car: 1 Wine. Alternatively, gains from trade: =0.4 wine = 0.5 car Gain Country B:1 unit of wine exported
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1. International transfer of __________ 2. Increasing ___________ in the domestic market 3. Raising the ________________ Other gains from trade technology competition standard of living
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Costs of conducting trade 1. Transportation cost _______ the gains from trade. 2. Political disturbance or war _____ the risk and hence _______ the gains from trade. reduces raises reduces
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If the terms of trade is 1C:1.9 W, what will be the gains from trade? For each unit of computers exported, gain for China = __________________ For each unit of computers imported, gain for the USA A = _________________ (1.9-1.11) W = 0.79 W (2- 1.9) W = 0.1 W( saved )
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Is it possible for a country to have comparative advantage in all the goods it produces? ___, it’s __________. So, when Country A’s opportunity cost of producing one good is lower than that of Country B, its opportunity cost of producing another good MUST be ______ than that of the Country B. It is because the opportunity cost of producing one good is the _________ of the opportunity cost of producing the other good. impossible reciprocal higher No
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‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. Absolute advantage: the country is more productive in producing a good with the _____ amount of resources than another country. It is ________ to the productivity of a country. same Comparative advantage: the country has a _____ opportunity cost of producing a good than another country. It is _________ to the productivity of a country. lower related unrelated
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‘Both absolute advantage and comparative advantage are related to the productivity of a country.’ Explain whether this statement is true or not. The Country A has _________________ in the production of both goods, but it has the ____________________ in producing wheat only. absolute advantage comparative advantage e.g.
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