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    INTERNATIONAL TRADE

    Dr. Nahla Azzam


    Lecturer of economics
    Faculty of Economic
    Studies and Political Science
    (ESPS)
    Alexandria University
    Email: [email protected]

    Lecture (2)
    8/10/2023
    2023/2024
    Part 1: International Trade Theory
    Chapter (2)
    The Law of Comparative Advantage
    Main points:

    1. Introduction.
    2. The Mercantilists’ Views on Trade.
    3. Trade Based on Absolute Advantage: Adam Smith.
    4. Trade Based on Comparative Advantage: David Ricardo.
    5. Comparative Advantage and Opportunity Costs.
    6. The Basis for and the Gains from Trade under Constant Costs.
    7. Empirical Tests of the Ricardian Model
    1. Introduction
    International trade theories basic questions and assumptions:
    ➢Basic questions:
    1. What is the basis for trade?
    • A nation engages in trade only if it benefits from trade, i.e., expected gains
    from trade are always representing the prime motive of trade.
    2. What are the gains from trade?
    • How gains from trade are generated? How large are these gains? And how are
    they divided among the trading nations?
    3. What is the pattern of trade?
    • How the structure of trade is determined?, What commodities are traded ,
    which are exported? and which are imported?
    ➢Basic assumptions of trade theories:

    1. Two-nation, two-commodities, and two factors world (L, K).

    2. No trade restrictions (tariffs & Quotas) i.e., free trade.

    3. Perfect mobility of factors within the nation, but no international


    mobility.

    4. Perfect competition in all commodity and factor markets, i.e., all


    products and factors are homogeneous.

    5. No transportation costs.
    2. The Mercantilists’ Views on Trade:
    • Mercantilism is an economic philosophy that
    existed in the 17th and 18th centuries, in England,
    Spain, France, Portugal and the Netherlands.
    • They believed that a nation could become rich and
    powerful only by exporting more than it imported.
    • Export surpluses is settled by an inflow of bullions
    of precious metals (mainly gold and silver).
    • Therefore, trade policy was to encourage exports and
    restrict imports.
    • Mercantilists measured wealth of a nation by the stock of precious metals it
    possessed.

    • Today, we measure wealth of a nation by its stock of human, man-made and


    natural resources available for producing goods and services.
    i.e., The greater the stock of resources, the greater the flow of goods and
    services to satisfy human wants, and the higher the standard of living.

    • However, since all nations could not have an export surplus, and the amount
    of gold & silver is fixed at any particular time, then trade is a Zero-sum
    game, i.e., one nation could gain only at the expense of other nations.
    3.Trade Based on Absolute Advantage: Adam
    Smith
    • Smith started with a simple truth that for two nations to
    trade with each other voluntarily, both nations must
    gain, (mutually beneficial trade).

    • According to smith trade between two nations is based on absolute


    advantage. When one nation is more efficient than another (has absolute
    advantage) in the production of one commodity but is less efficient than the
    other (has absolute disadvantage) in producing a second commodity.
    ⸫ Both nations can gain by each specializing in the production of the commodity
    of its absolute advantage, and exchange part of its output with the other nation
    for the commodity of its absolute disadvantage.
    Example:
    • Canada is efficient in growing wheat, inefficient in growing bananas.
    • Nicaragua is efficient in growing bananas, inefficient in growing wheat.
    ⸫ Canada has absolute advantage in wheat, while Nicaragua has absolute
    advantage in bananas.

    • Mutually beneficial trade can take place if both countries specialize in their
    absolute advantage.
    ⸫ Canada Export wheat and Import bananas
    Nicaragua Export bananas and Import wheat

    • By this process:
    ✓ resources are efficiently utilized.
    ✓ Total output of both commodities is maximized.
    ✓ welfare of both countries is maximized.
    Illustration of absolute advantage:
    U.S. U.K.
    Wheat (bushels/labor hour) 6 1
    Cloth (yards/labor hour) 4 5
    Note: productivity is measured here using working hours, i.e., efficiency increases the less
    time (resources) used to produce an amount of a good, or the more quantity is produced per a
    specific time period (one man hour).
    Before trade:
    ⸪ One hour of labor time produces 6 bushels of wheat in U.S., but only 1 bushel
    in U.K.
    ⸪ One hour of labor time produces 5 yards of cloth in U.K., but only 4 in U.S.
    ⸫ U.S. is more efficient than, or has an absolute advantage over U.K. in the
    production of wheat.
    ⸫ U.K. is more efficient than, or has an absolute advantage over U.S. in the
    production of cloth.
    With trade:
    The U.S. could specialize in the production of wheat and exchange part of its
    production for British cloth, and the opposite is true for U.K.

    Gains from trade:


    Suppose that U.S. exchanges 6W for 6C, then:
    • The U.S. gains 2C or saves ½ man- hour (since domestically it needs 1 ½
    to produce 6C).
    • The U.K. will receive 6W, which can be produces domestically in 6 hrs.
    These 6 hrs can produce 30C (6 hours x 5 yards of cloth/ hr), then
    exchanging 6W for only 6C U.K. gains 24C. Also, 6C can be
    domestically produced in 1 1/5 hr only, therefore, the U.K. saves 4 4/5 hrs.
    • The fact that the U.K. gains much more than U.S. is not important here,
    what matters is that both nations can gain from specialization in
    production and trade.
    Notice that:

    • While the mercantilists believed that one nation could gain only at the
    expense of another nation and advocated strict government control on
    economic activity and trade, we realize that specialization and trade
    advantage both countries.

    • Adam Smith and other classical economists believed that all nations
    would gain from free trade, and so he strongly advocated policy of
    laissez-faire, or minimal government interference in economic activity.

    • Free trade would cause world resources to be utilized most efficiently,


    maximizing world welfare.

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