1. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 1 2 countries; A and B Comparative advantage (technology differences) International trade based on differences in technologyassumptions No transport costs 2 goods; X and Y 1 factor of production; labor L Constant returns to scale; CRS Labor mobility between sectors, not between countries Perfect competition unit labor requirement= units of labor required to produce one unit of a final good By assumption this is independent of the number of laborers active in a sector (CRS), but may differ between the two countries. Let a x be the for good X in country A, etcunit labor requirement

2. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 2 We can make a table to summarize the state of technology good Xgood Y country A country B ayay axax bxbx byby To be concrete we put some actual numbers in the table = 6= 4 = 2= 3 Note that country B is more efficient than country A; it uses less labor to produce 1 unit of good X and it uses less labor to produce 1 unit of good Y. Why on earth would it trade with country A? Comparative advantage (technology differences)

3. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 3 Assume that country A has 600 laborers and country B has 300 Recall the productivity table good Xgood Y country A country B ayay axax bxbx byby = 6= 4 = 2= 3 First we derive the production possibility frontiers Country A can produce 600/6 = 100 of X;or 600/4 = 150 of Y Country B can produce 300/2 = 150 of X;or 300/3 = 100 of Y Comparative advantage (technology differences)

4. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 4 Country A can thus produce at most 100 X or 150 Y X Y 0 If 12 Labor is moved from Y to X country A produces 3 less Y and 2 more X; independent of the initial point Country A’s ppf is thus a straight line (because of CRS and 1 factor of production) Similarly for country B A B Suppose that consumers in country A and in country B always want to consume at least some of both goods 100 150 100 Comparative advantage (technology differences)

5. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 5 X Y 0 In autarky (without trade) country A might produce and consume At point A, country B at point B A B Note that if country A wanted to change its consumption point it would have to move along its own ppf. If A wants to consume more X it has to give up 6/4 = 1.5 units of Y A’s opportunity cost of X is 1.5 Y If B wants to consume more X it has to give up 2/3 = 0.66 of Y B’s opportunity cost of X is only 0.66 Y Comparative advantage (technology differences)

6. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 6 The opportunity cost differences are evident from the table good Xgood Y country A country B ayay axax bxbx byby If A wants to consume 1 more X it needs a x labor. These have to come from sector Y, where a x labor could have produced a x /a y of Y = 6= 4 = 2= 3 Similarly, for B the opportunity cost of X is b x /b y of Y Good X is relatively expensive in country A if its opportunity cost in terms of Y are larger than in B, i.e. if a x /a y > b x /b y For country B this implies that the opportunity cost of X is low relative to country A: Country B has a comparative advantage in X For country A the opportunity cost of Y in terms of X is low relative to country B: Country A has a comparative advantage in Y a x /a y = 1.5 b x /b y =.66 Comparative advantage (technology differences)

7. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 7 That is the have to coincide The differences in opportunity costs give rise to gains from trade X Y 0 A B If A specializes in the production of X and B in the production of Y A pr They may trade with each other, say at p x /p y = 0.90 B pr Say A wants to buy 40 XIt has to pay 36 Y And might produce at A pr and consume at A c AcAc BcBc In exchange for 40 X trade triangles Provided B is willing to demand 36 Y Both countries gain: they consume more after trade Comparative advantage (technology differences)