1. Insights and Review Humian adjustment (David Hume, 1711-1776) An early equilibrium model Suppose one country enjoys a balance of trade surplus – –It’s trading partner experiences a deficit “Gold” flows from deficit country to surplus country – –The surplus country’s money supply increases – –Prices rise in the surplus country The surplus country’s goods become less attractive – –It sells less to the other country – –It buys more from the other country The balance of trade balances

2. Insights and Review A country enjoys a comparative advantage in the good for which its opportunity cost of production is low. Trade proceeds as long as the terms of trade (wine/cloth) is less than the wine exporting country’s opportunity cost of producing cloth and greater than the wine importing country’s opportunity cost of producing cloth. – –The wine exporting country trades less of its wine for cloth than it would have to sacrifice in autarky – –The wine importing country gets more wine for its cloth than it would get in autarky In general, a country’s Terms of Trade equals Price It Receives for Its Exports/Price It Pays for Its Imports – –The closer the terms of trade are to its own opportunity cost, the less a country gains from trade: it may as well not trade – –If its demand for the good it imports is high, it will pay a high price for its import and not gain much from trade.

3. Insights and Review If a country is not competitive because its workers are inefficient or “overpaid” (its costs are high), it can become competitive by – –Depreciation of its currency But if its exchange rate is fixed – –It pays for its import surplus with “gold” (Hume) – –Its wages and prices deflate … while wages and prices in the export surplus country inflate Or – –If its workers resist taking wage cuts, they suffer unemployment –Its trade balances because it imports less

4. Trading Under Increasing Costs: Comparative Advantage: US  Autos, CN  Wheat

5. Supply schedule under increasing costs Increasing opportunity costs

6. U.S. “Comparative Advantage” by Sector (2000): Ratio of Net Exports:Total Trade (Exports + Imports) Agricultural Products+0.77 Chemicals+0.21 Machinery+0.02 Telecommunications Equipment -0.01 Medical Equipment -0.02 Industrial Supplies -0.28 Civilian Aircraft -0.29 Automotive Equipment -0.42 Consumer Goods -0.51 Steel -0.51 Petroleum -0.82

7. Dynamic Gains from Trade Competitive pressure  Efficiency – –Domestic suppliers must compete globally – –The firm itself must compete globally Technology transfer  Efficiency Increased extent of the market  Economies of scale  Efficiency

8. Problem 2.12 Comparative Advantage Production Possibilities Canada France Canada France Steel 500 1,200 Aluminum 1,500 800 Opportunity cost, AL Opportunity cost, ST Suppose w/o trade, each divides resources equally between steel and aluminum production At terms of trade = 1 AL:1 ST, 500 ST  500 AL What are gains? Show trade triangles.