Chapter 3: Comparative Advantage and the Gains from Trade

Chapter 4: Comparative Advantage and Factor Endowments

Class Notes: these count for 1% of your total grade

1. Define the following

Mercantilism: the system of nationalistic economics that dominated economic thought in the
1700s
Absolute productivity advantage: The advantage held by a country that produces more of a
certain good per hour worked than another
Production possibilities curve shows the tradeoffs a country faces when choosing between two
goods
Autarky: The complete absence of trade; all nations can only consume the goods they produce at
home
Comparative productivity advantage is if a country’s opportunity costs of producing a good are
lower than those of its trading partners.
2. An opportunity cost ratio reveals what for a nation?
As long as the trade price is less than the opportunity cost of producing a good, a country is
better off buying it than making it
3. How do we determine a trade price for two countries when they have an absolute or
comparative advantage?
4. For the two countries above, how can you determine who has the absolute advantage in
each good?
Country 1 has the absolute advantage in Tacos
Country 2 has the absolute advantage in Pizza
5. For the two countries above, how can you determine (and who has each) the comparative
advantage for each good?
Opportunity Cost:
Country 1:
Producing 1 taco costs 30/50 = 0.6 pizzas
Producing 1 pizza costs 50/30 = 1.67 tacos
Country 2:
Producing 1 taco costs 60/30 = 2 pizzas
Producing 1 pizza costs 30/60 = 0.5 tacos
Country 1's opportunity cost of producing 1 taco is lower than Country 2’s opportunity cost of
producing 1 taco. So, Country 1 has a comparative advantage in producing taco.
On the other hand, Country 2's opportunity cost of producing 1 pizza is lower than Country 1's
opportunity cost of producing 1 pizza. So, Country 2 has a comparative advantage in producing
pizza.
6. If each country devotes half their labor to each good, how much will each country
produce of each good?
b _____25
b’ _____15
c _____15
c’_____30
7. What is the opportunity cost for country 1 when it comes to making tacos?
Producing 1 taco costs 30/50 = 0.6 pizzas
8. What is the opportunity cost for country 2 when it comes to making tacos?
Producing 1 taco costs 60/30 = 2 pizzas
9. If each country were to specialize in their comparative advantage they would produce
Country 1 ________taco
Country 2 ________pizza
10. What is a reasonable terms of trade for each country (hint: it lies in-between their
opportunity cost ratios)?
A reasonable terms of trade has to be between 0.6 and 2 pizzas per taco
So it’s a pizza for a taco or any ration between the 2 opportunity cost ratios.
11. The Hecksher-Ohlin model of trade relies on what two aspects to determine which
country exports which good?
Factor intensity of production: This pertains to the intensity with which a good uses a particular
factor in its production process.
Relative factor abundance: This refers to the relative abundance or scarcity of inputs (like capital
and labor) in a country.
12. Mathematically, what does your answer from 11 look like (i.e. no numbers are needed
just ratios)?
The HO Model: 2x2x2
– 2 inputs, called labor and capital.
– 2 outputs, called bread and steel.
– 2 countries, called the U.S. and Canada.
• Relative factor endowments are the ratios of capital to labor.
– Written: K/L
United States Canada
Capital 50 machines 2 machines
Labor 150 workers 10 workers
Factor abundance depends on the ratios of K to L.
– KCA / LCA = 2 / 10 = 1/5.
– KUS / LUS = 50 / 150 = 1/3.
• Since KUS / LUS > KCA / LCA the US is capital abundant compared
to Canada and Canada is labor abundant compared to the U.S.
13. Provide an example that shows 1 country being capital abundant and the other country
being labor abundant. Also, provide an example that show one good being capital intensive
and the other being labor intensive. Finally, which country exports which good?
 Philippines Viet Nam
Capital 30 machines 20 machines
Labor 60 workers 100 workers
Factor abundance depends on the ratios of K to L.
– KVN / LVN = 20 / 100 = 1/5.
– KCNA / LCNA = 30 / 60 = 1/3.
• Since KCNA / LCNA > KVN / LVN Philippines is capital abundant compared
to Viet Nam and Viet Nam is labor abundant compared to Philippines.