Lecture_02_2011

Lecture_02_2011 - The Global Economy ECON 5319 Comparative...

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The Global Economy ECON 5319 Comparative Advantage and the Gains from Trade William J. Crowder Ph.D.
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Adam Smith and the Attack on Economic Nationalism • In 1776, Adam Smith published the first modern statement of economic theory, An Inquiry into the Nature and Causes of the Wealth of Nations The Wealth of Nations attacked mercantilism —the system of nationalistic economics that dominated economic thought in the 1700s – Smith proved wrong the belief that trade was a zero sum game —that the gain of one nation from trade was the loss of another – Voluntary exchange (trade) is a positive sum game —both nations gain
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Implications of Adam Smith’s Theory • Access to foreign markets helps create wealth – If no nation imports, every company will be limited by the size of its home country market – Imports enable a country to obtain goods that it cannot make itself or can make only at very high costs – Trade barriers decrease the size of the potential market, hampering the prospects of specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth creation
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Adam Smith and Trade Barriers • Smith was highly critical of trade barriers • Trade barriers decrease - Specialization - Technological progress - Wealth creation • The modern view of trade shares Smith’s dislike for trade barriers
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A Simple Model of Production and Trade • A basic model, often referred to as the Ricardian model, named after economist David Ricardo • Assumptions – Markets are competitive: Firms are price takers – Static world: Technology is constant and there are no learning effects – Labor is perfectly mobile: It can easily move back and forth between industries
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Absolute Productivity Advantage and the Gains from Trade Productivity : The amount of output obtained from a unit of input Labor productivity : (units of output) / (hours worked) If two loaves of bread can be produced in 1 hour, productivity = (2 loaves) / (1 hour) Absolute productivity advantage : The advantage held by a country that produces more of a certain good per hour worked than another
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Output per Hour Worked
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Absolute Productivity Advantage and the Gains from Trade (cont.) •T h e U . S . opportunity cost of bread is 1.5 tons of steel: each unit of bread produced requires the U.S. economy to forfeit the production of 1.5 tons of steel • In sum, trade between U.S. and Canada will occur at a price between these two limits: P US b = 3 tons 2 loaves = 1.5 tons loaves 3.0 loaves ton > W S P > 0.67 loaves ton
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Comparative Productivity Advantage and the Gains from Trade (cont.) • Question: What happens to a country that does not have absolute productivity advantage in anything? • Answer: Even if a country does not have any
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This note was uploaded on 07/16/2011 for the course ECON 5319 taught by Professor Crowder during the Spring '11 term at UT Arlington.

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Lecture_02_2011 - The Global Economy ECON 5319 Comparative...

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