Download comparative advantage

CHAPTER 5:
The Foreign
Sector
Globalisation
Characterised by…
 expansion of trade between countries
 capital markets sprung up in developing and
former centrally planned economies
 tourism has increased
 new technologies have linked the farthest
corners of the world
HOMEWORK
 Read Box 5-1 on pages 102, 103
Why countries trade
Self-sufficiency (or autarky) used to be popular among politicians
and citizens who wanted to be independent.
Countries gain if every country specialises and exports surplus
not consumed domestically and import goods which not
produced domestically.
Extract from Adam Smith’s ‘Wealth
of Nations’ (1776)
“It is the maxim of every prudent master of a family,
never to attempt to make at home what it will cost him
more to make than to buy ... What is prudence in the
conduct of every private family, can scarce be folly in
that of a great kingdom. If a foreign country can supply
us with a commodity cheaper than we ourselves can
make it, better buy it of them with some part of the
produce of our own industry, employed in a way in
which we have some advantage.”
More reasons to trade…
SA has…
but no…
Trade between countries
But what if both countries produce both wool and rubber? Will
trade still be desirable or possible under such conditions?
Assumptions…
 only two countries
 each of which producing two goods
 goods are exchanged directly for goods (ignore exchange
rates)
Absolute and Comparative
Advantage Example
You’re given the following info. about a newlywed
couple and the time it takes each of them to do
different chores: vacuuming a room or washing a load
of dishes.
Absolute Advantage
Absolute Advantage: The person, firm, or nation with a
higher level of productivity compared to that of another.
 Who has the absolute advantage in vacuuming?
 Debbie
 Who has the absolute advantage in washing dishes?
 Neither
Q:What
opportunity
cost
Q;What
Whatis
isDebbie’s
Mike’sopportunity
opportunity
cost
ofof
Q:
is
Mike’s
cost
of
Q: What
Debbie’s
opportunity
cost of
A:isWashing
2/3
of dishes.
A: Washing
1
1/3
loads
of
dishes.
A:
Vacuuming
¾
of
a
room.
vacuuming
in
terms
of
washing
washing
dishes
in
terms
of
vacuuming
in
terms
washing
washing
dishes
inof
terms
of
Vacuuming
1½
room.
dishes?
vacuuming?
dishes?
vacuuming?
OC of vacuuming= Time spent vacuuming a room
Time spent washing dishes
Comparative Advantage
Comparative Advantage: the person, firm, or nation with the
lower opportunity cost vs. that of another.
 Who has the comparative advantage in vacuuming?
 Debbie
 Who has the comparative advantage in washing dishes?
 Mike
Shirts
(per worker/week)
Cellphones
(per worker/week)
50
100
150
10
5
15
Absolute advantage between countries
South Africa
Zimbabwe
TOTAL
Zimbabwe has an absolute advantage in the
production of _______
South Africa has an absolute advantage in the
production of _______
Gains from specialisation and trade
What would happen if both countries
specialised ?
South Africa
Zimbabwe
TOTAL (prev. total)
Shirts
(per worker/week)
Cellphones
(per worker/week)
0
200
200 (150)
20
0
20 (15)
Comparative (relative) advantage
All that is required for both
countries to benefit from
trade is that the
opportunity costs of
production differ between
the two countries.
David Ricardo (1772–1823)
Comparative Advantage Example
South Africa
Germany
Cars
(per day)
Barrels of wine
(per day)
1
2
6
8
 Germany has an absolute advantage over South
Africa in the production of __________.
Cars
(per day)
Barrels of wine
(per day)
1
2
6
8
Gains from trade
South Africa
Germany
 Germany has a relative or comparative advantage in the
 Has Germany got anything to gain from trading with South
production of _______
Africa???
 South Africa has a relative or comparative advantage in the
 Lets look at the OC of production…
production of _______
OC of producing 1
OC of producing 1
Car
Barrel of wine
South Africa
Germany
6
4
1/6
1/4
OC of producing 1
Car
OC of producing 1
Barrel of wine
South Africa
6
1/6
Germany
4
1/4
Terms of trade
South Africa will shift resources into wine production if it
can exchange fewer than 6 barrels of wine for a car from
Germany.
Germany will shift resources into car production if it can
obtain more than 4 barrels of wine for every car it sends to
South Africa.
Beneficial if 1 car is exchanged for more than 4 but fewer
than 6 barrels of wine.
Gains From Trade
Suppose 1 car exchanges for 5 barrels of wine:
Germany receives 5 barrels of wine for each car sent to
SA. Beneficial for Germany to shift resources from wine
to car production and trade the excess cars.
Without trade: 4 barrels of wine for each car sacrificed.
After trade: 5 barrels of wine for each car given up.
Gains From Trade
Suppose 1 car exchanges for 5 barrels of wine:
South Africa receives 1 car for 5 barrels of wine it sends
to Germany. Beneficial for South Africa to shift
resources from car to wine production and trade the
excess.
Without trade: 1 car for 6 barrels of wine sacrificed.
After trade: 1 car for 5 barrels of wine given up.
Trade policy
International imports can hurt local firms.
Gov. policies to protect domestic firms include…
 Import tariffs: duties or taxes imposed on products imported
into a country.
 Import quotas: control number of imports
 Subsidies: lowers the cots of domestic producers.
Non-tariff barriers
 discriminatory administrative practices, for example…




Deliberately awarding government contracts to domestic firms
insisting on technical standards difficult for foreign firms to meet
special licensing requirements
unnecessary red tape.
 Exchange rate policy: movements in exchange rates may have
significant effects on exports and imports
Exchange rates
SA importers pay in foreign currencies for goods/services and
exchange SA rand for foreign currencies.
SA importers demand foreign currencies.
Other countries, pay in rand for SA exports and exchange
foreign currencies for rand
SA exports lead to a supply of foreign currency.
Rate at which currencies are exchanged = rate of exchange
or exchange rate.
Exchange rates simply represents the price of
one currency in terms of another.
Increase in the value of one currency in terms
of another (appreciation) implies a decrease
(depreciation) in the value of the other
currency.
$ per £
S£
1.90
1.85
The
rise an
in in
Assume
initial
Investing
demand
creates
exchange
rate of
the UK would
a
shortage
in£
£1
= be
$1.85.
now
more
and
price
There
are ofand
attractive
£1(exchange
rumours that the
demand
for £
rate)
UK is would
going to
would
increaserise
interest
rates
D£1
Shortage
D£
Q1
Q3
Q2
Quantity on
ForEx Markets