Chap-8 - COMPARATIVE ADVANTAGE, INTERNATIONAL TRADE AND...

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In previous chapters we studied how producers and households interact with each other in product and factor markets. We can think of such interaction as “trade” between producers and households, in the sense that each party has something to offer to the other. Not only producers and consumers within a country trade with each other, the countries themselves, i.e., consumers and producers across countries, trade/exchange with each other in goods and services. This is called international trade . As an example of trade in goods, India exports tea to the rest of the world and imports petrol. Many foreign banks today offer banking services in India, which is an example of trade in services. In this chapter, our objective is to learn some fundamentals of international trade. This is very important, because countries, in general, are much more interdependent today than they were 30 or 40 years ago. In the process, we learn a very important concept in economics, called comparative advantage . Through this concept, we will understand that promoting international trade is not a bad thing, and, it is not true that, if one country gains from it, some other country has to lose. On the contrary, we will C OMPARATIVE A DVANTAGE , I NTERNATIONAL T RADE AND F ACTOR M OBILITY C HAPTER 8 8.1 Ricardo's Theory of Comparative Advantage and Benefit from Trade 8.2 Factor Endowment Theory of International
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I NTRODUCTORY M ICROECONOMICS 138 learn that trading with each other is, by and large, a mutually beneficial activity. The idea behind comparative advantage (to be defined in Section 8.1) and gains from trade can be understood through this example. Suppose that you are a very good pop singer and a very good cook. But you are much more productive as a singer than as a cook. This is in the sense that if you sing you get Rs. 5,000 per hour, whereas you can hire an excellent cook at the rate of Rs. 300 per hour, i.e., if you cook, you save Rs. 300 per hour. One option for you will be to pursue a singing career and still cook for yourself – be “self- sufficient”, so-to-speak. That is, you are capable of doing both and you actually choose to do both. Consider now the alternative option of hiring a cook and engaging yourself full time in singing. Which option will you prefer? Surely, the latter. Now think about this example in a different light. The option to do both activities is like choosing not to do trade between your service as a cook and your service as a singer. The latter option is like importing the service that you do not have comparative advantage in (that is, cooking) and, specialising and exporting the service you have comparative advantage in (that is, singing). What applies for an individual in the above example also applies to a country. A country, in comparison to producing all goods it can produce and not trading, is better off by (a) producing more of the goods which it can produce relatively cheaply and exporting part of them and (b) producing less – possibly none – of the goods which it cannot produce
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Chap-8 - COMPARATIVE ADVANTAGE, INTERNATIONAL TRADE AND...

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