Download Course Learning Outcomes for Unit III Unit Lesson Reading

UNIT III STUDY GUIDE
International Trade Theories
Reading
Assignment
Chapters 5:
International Trade and
Factor-Mobility Theory
Course Learning Outcomes for Unit III
Upon completion of this unit, students should be able to:
4. Differentiate between absolute advantage and comparative advantage trade
theories.
4.1 Examine the theory of absolute advantage and factor mobility.
4.2 Examine the theory of comparative advantage.
4.3 Apply opportunity costs.
Unit Lesson
Theory of Mercantilism vs. Neomercantilism
Mercantilism is the oldest form of economic theory. According to Daniels,
Radebaugh, and Sullivan (2015), this economic thought was the foundation from
about 1500 to 1800. The beliefs were that exports were good and imports were
bad; in essence, countries should export more than they import.
In 1776, economist Adam Smith attacked the mercantilism view by arguing that
free trade does not come from stocks of precious metal but of factors of production
(land, labor, and capital) (London, 2013).
Absolute Advantage
Adam Smith stated that countries produce some goods more efficiently than others
and reasoned that unrestricted trade could lead a country to specialize in those
products that give it a competitive advantage.
In other words, the country that produces more of one product has absolute
advantage in producing that product. To illustrate the concepts of absolute
advantage and comparative advantage, we are going to use two countries and two
products. See the Table 1 example below:
Chairs
United States
Mexico
Total
100
80
180
Desks
75
100
175
Table 1
In the example in Table 1, the United States has absolute advantage in chairs, and
Mexico has absolute advantage in desks. The total represents world production.
The sensible thing is to specialize, that is, take all of the resources (labor and
capital) to produce that product they are good at producing. See Table 2:
MBA 6601, International Business
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United States
Mexico
Total
Chairs
200
0
200
Desks
0
200
200
Table 2
Because all of the resources (labor and capital) were used to produce the one
product that they were efficient in, world production increased by 20 in chairs and
25 in desks. Now, the two countries can trade with increased production.
Comparative Advantage
In the early 19th century, a British economist, David Ricardo, questioned Adam
Smith’s theory on absolute advantage; what if a country is efficient at producing
both products? In this case, trade would not take place because the United States
is efficient at producing both goods. See Table 3 below:
United States
Chairs
100
Desks
85
Mexico
Total
90
190
80
165
Table 3
In this case, the United States can produce more of each good than Mexico. However,
Mexico can produce can only produce 90% of desks and 94% of chairs compared to
the United States. In this case, Mexico has comparative advantage in desks, and the
United States has comparative advantage in chairs. With this concept of comparative
advantage, the United States should produce chairs and Mexico should produce
desks, and then trade could take place.
Opportunity Costs
Let’s look at another concept called opportunity cost. As defined by Merriam-Webster
dictionary (2014):
the added cost of using resources (as for production) that is the difference
between the actual value resulting from such use and that of an alternative (as
another use of the same resources or an investment of equal risk but greater
return). (para. 1)
Therefore, the United States could produce either 200 units of chairs or 160 units of
desks. Mexico could produce 180 units of chairs and 170 units of desks. If the United
States produces only chairs, it gives up 80 units of desks to gain 100 units of chairs. If
Mexico produces only chairs, it gives up 85 units of desks to gain 90 units of chairs.
Therefore, the opportunity cost of producing desks is higher for the United States, and
the opportunity cost of producing chairs is lower. The opportunity cost of producing
chairs is higher for Mexico, and the opportunity cost of producing desks is lower.
Again, the United States has comparative advantage in chairs, and Mexico has
comparative advantage in desks.
United States
Mexico
Total
Chairs
200
0
200
Desks
0
170
170
Table 3
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By specializing, the United States has increased production of 10 units of chairs and
Mexico has increased production of 5 units of desks, and now trade should take place
with increased production.
Note: You can have absolute advantage in both goods but only comparative
advantage in one.
References
Daniels, J. D., Radebaugh, L. H., & Sullivan, D. P. (2015). International business:
Environments and operations (15th ed.). Upper Saddle River, NJ: Pearson
Education.
London, C. W. (2013, August 23). What was mercantilism? [Web log message].
Retrieved from
http://www.economist.com/blogs/freeexchange/2013/08/economic-history
Opportunity cost. (2014). In Merriam-Webster’s online dictionary. Retrieved from
http://www.merriam-webster.com/dictionary/opportunity%20cost
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