I. The fundamentals of international trade
A. David Ricardo's trade according to comparative advantage

End of last class, we showed that you can determine comparative advantage without knowing anything at all about wealth, productivity or wages:

Example: Alemania: Pw = 4 x Pb => MCw = 4 x MCb => OC1w = 4B

Even though all you know are prices in domestic currencies, you can figure out that Alemania has a CA in beer and Vinland has a CA in wine. No information here about wages or productivity

    Absolute advantage relates outputs to inputs.
        -- absolute productivity matters for wages
    Comparative advantage relates outputs to each other.
        -- absolute productivity does not matter for trade

Quote 4: "China can manufacture anything cheaper than any other nation."
    If true, then China must have an absolute advantage in everything.
    But as far as trade goes, that doesn't tell us what we need to know
    China would still not want to export to everyone and get nothing back.
    If China engages in international trade, then it still find it beneficial to to exploit its comparative advantage

    Lack C/A only if relative product costs are the same at home as they are on the world market, a remarkable coincidence.
    Ex: World market: Pcoffee = Pbeans = Pcoca leaves
    Unlikely to be the same in Colombia before trading.
    One price is bound to be out of line--say coca leaves cheaper in Colombia.
    Export the relatively cheap item.
    Other items are ipso facto relatively expensive. Import them.

    The lack of such an opportunity becomes more implausible as the number of goods grows

The gains from trade

    Quote #3: Recall the trade quote regarding Peter Angelos: According to the LA Times Magazine, 2/26/1995: His credo is always "to buy American." When bestselling author Tom Clancy, an Orioles investor, bought a Mercedes-Benz, Angelos called it "a German piece of s- - -." Clancy has since purchased a Cadillac, the same brand Angelos owns (his wife drives a Lincoln). It is every American's responsibility, Angelos says, "to buy American, even if it's inferior to a foreign product. You have to support your fellow Americans."

    This turns out to be another popular misconception. Trade theory suggests the opposite outcome from trade:

    Does trade make a country better off?
    Compared to what?

    (1) a relevant benchmark: no trade -- called autarky

    Trade should never make a country worse off than autarky
    Since trade = indirect production, you should never settle for giving up more when you trade for an item than you would have to give up to make the item yourself

    (2) an irrelevant benchmark -- the past
    you can't turn back the clock
    US: privileged market position in the past: autos / aircraft / movies
    We can stop importing cars--that gives us a relevant comparison to our present situation
    We cannot force the rest of the world to go back to buying ours, as they did in the 1950s.

    Can we be sure that trade will make both countries better off than they are without trade?

    Intuition: it should, because trade is, after all voluntary exchange, so why do it if you don't end up better off as a consequence. Since trade gives you a better buy on one of the goods you consume, you figure to have better consumption possibilities than before.

    Example: Basic gains from trade worksheet
    row a: specialization -- shift production to CA industries
    row b: exchange (trade) -- exchange your low OC for your high OC goods

    Trade according to C/A gives the world more goods to divide up
    Both countries end up consuming more than before

Recall: What does the slope a PPF tell us? (OC of good X in terms of good Y)     Gains from trade: Trade according to comparative advantage makes a country better off by allowing it to consume more than it can produce itself.     You consume outside your own PPF     Recall the basic intuition: Trade = an indirect method of production.     So you can never be made to give up more when you trade for an item than you would have to give up to make the item yourself

    Notice: If you follow Peter Angelos' advice, you move back to your PPF.
    ? So why do you think a presumably well-intentioned individual like Peter Angelos would advise us to do that?
    Many, perhaps Angelos, see the harm done to import-competing producers, the easiest to observe, but don't see the gain to consumers and exporters.
    Since trade increases the size of the pie, these gains that many don't see are larger than the losses that they do see.

    Recap: We've just scratched the surface of trade analysis so far.
    But the key result of gains from trade analysis is unambiguous:
    By simply reallocating the resources we have and then trading, we can end up consuming more than we could ever produce ourselves. It frees us from the constraints of our own PPF.
    Trade can give us the closest thing in economics to a free lunch.

    Maybe you're lucky--athletic, smart, talented, chose Oxy
    Still, pays to pick something you're especially good at and trade the fruits of your labor for things you want that others make
    You'll be rich because you're talented
    You'll be even richer because you're specializing

    Maybe you're not so lucky--clumsy, slow, went to another college
    Still, you can in most cases do something
    Do it.
    You'll be poor because you're not talented
    You'll be less poor because you're specializing

    The same holds for nations: C/A trade makes rich countries even richer. But not at the expense of poor countries. C/A trade may not make a poor country rich, but it does make the country richer than it would otherwise be.

    Other influences, such as education, infrastructure, investment, domestic policies are also important for development.
    But C/A trade, by raising income, does provide more resources for these other purposes.
    Important to distinguish between how a country earns its income from how the country spends it.
    No criticism here of spending income in a way which changes a country's C/A over time.
    That's what happens as countries develop (as in Japan and now South Korea)
    As C/A changes, so will trade pattern.
    But it rarely makes sense to change your trade pattern before your C/A changes. Putting the cart before the horse reduces the resources available to a country for dev't purposes.

I. The fundamentals of international trade
B. Supply and demand trade geometry

    Supply and demand geometry can be used to easily depict imports, exports and the gains from trade.
    We'll use ordinary domestic-market supply and demand whenever we can.

Basic concepts

(1) small versus large trading countries

    small => too small for its trade to affect world prices
    Global prices don't change no matter how little or much it trades
    Can buy or sell as much of a product as it wants at the going world price
    Ex: Ecuador as an oil producer

    We can usually trace the effects of trade on a small country by looking just at a domestic market diagram

    Large => its trade activities do affect world prices
    Large in an export market: as the country exports more, it drives down the world price of the item
    --Faces a downward sloping demand curve for its exports
    ? Ex? Saudi Arabia as an oil producer

    Large in an import market: As the country imports more, it drives up the world price of the item
    --Faces an upward sloping supply curve for its imports
    ? Ex? Harder to find--perhaps US as an ATV importer

    For a large country, we generally have to turn to an international market diagram to see the full effects of trade

(2) the gains from market transactions

    Review of what's so good about a market equilibrium
    Why are economists fond of it?

Example: the barley market:

    The question here is, how can we measure the well being we get from having the equilibrium quantity of barley?

    Economic decisions are based on comparing benefits and costs
    Two groups to keep track of here: consumers and producers

    To get at the net gains of these two parties, recall:
    D = MB curve: for any unit consumed, height up to D
        = the value of that unit to its buyer (stack of coins up to D)
    S = MC curve: for any unit produced, height up to S

        Q<Q*: worthwhile units: MB>MC
        Q>Q*: not worthwhile units: MB<MC

    Now consider the total benefits and costs for each party when we have the equilibrium quantity to consume:

Consumer surplus (CS) = area between demand and price out to Q consumed     Producer surplus (PS) = area between price and supply out to Q produced     Total welfare = CS + PS