Chapter 2

Absolute advantage:

When one country can produce a certain good at a lower real cost
than another

Comparative advantage: Producing a good with a lower opportunity cost as compared to

another country

Example

Bart
Lisa

Hats
3
8

Coats
1
4

Who has comp adv?

Bart 1 hat = 1/3 coats

Lisa 1 hat = 4/8=1/2 coats

1/3 is less than , so bart does in hats

Bart 1 coat = 3 hats

Lisa 1 coat = 2 hats

2 is less than 3, so lisa has comp adv in coats

A
B
A
B

Always do this
comparison, and choose
the smallest number for
each pair

Chapter 3
The Hecksher-Ohlin theory states that countries specialize in producing goods that use up their
abundant FOP
-

Different products require productive factors in different proportions

Countries have different endowments of FOP

I.E. Capital intensive countries will produce machinery/cars etc.. whereas agriculture intensive make food
A countrys comparative advantage changes in accordance to changes in its factor supplies
Liberalization of trade causes the abundant factor to gain, and the scarce factor to lose
However, even if society has a whole incurs a net gain, some people (related to the scarce factors that dropped) will
lose and they make care about their losses more than the people who gained care about their gains, welfare can fall

However, Leontief found a flaw in the theory. Leontief conducted research and found that US
imports were more capital intensive that exports. However, he did find out what explained this
paradox. It was later found that Leontief assumed that there were only 2 homogenous F.O.P:
labor and capital. Leontiefs failure to take into account how other factors of production take part
in Intl trade patterns may explain how he got his paradoxical results.

LDC consume at point A, at a price of (Pa/Pm)L

Developed countries will produce at A at a price (Pa/Pm)R which differs because agricultural goods are
more expensive for them, and/or capital goods are cheaper

Both points have different points, thus different costs

Also both have different PP (production frontiers) because of different costs of producing
manufacturing/agri goods

They will take advantage of their opp cost in agri/man and produce at ponts B/B respectively

Conclusion
(1) Countries will produce goods for which they have abundant FOP, and import for which they
have scarce goods.
Never complete specialization in a specific good due to increasing opportunity costs

(2) Due to identical technology across countries, domestic price ratios and intl price ratios will
equalize

(3) Returns of goods used by abundant FOP is more than returns of goods made by scare FOP

(4) Since countries trade between each other to go outside their PPP and obtain goods that they
couldnt make, economic growth is achieved