Overview
This lecture covers key trade theories, focusing on how countries benefit from specializing and trading goods according to absolute and comparative advantage, as well as related policies and assumptions.
Specialization and Trade
- Countries specialize in producing goods they make most efficiently and trade for goods others produce efficiently.
- Efficient specialization and trade increase total global production.
- Natural resources often dictate obvious trade patterns (e.g., cocoa in Ghana, coffee in Brazil).
Theories of Trade
- Trade reflects where factors of production (land, labor, capital) and demand exist.
- Krugman's trade theory emphasizes firm limits and production resources.
- Porter's theory adds domestic demand and rivalry, which drive competitive advantage.
- Mercantilism sees trade as a zero-sum game, favoring trade surpluses.
- Smith's policy supports unrestricted (free) trade.
- Porter's approach suggests a balanced, regulated approach to trade.
Absolute and Comparative Advantage
- Absolute advantage: a country produces a good using fewer resources than others.
- Comparative advantage: even if a country is better at producing all goods, it should specialize where it is most efficient.
- Example: Ghana is more efficient at producing cocoa; South Korea at rice—both gain by specializing and trading.
Trade Examples and Calculations
- Without trade, both countries produce both goods, resulting in lower total output.
- When each country specializes in its comparative advantage and trades, total world output increases.
- Even if one country is better at producing both goods (absolute advantage), both still benefit from specialization and trade.
Assumptions and Limitations
- Classic trade theory assumes two countries, two goods, no transportation costs, and no resource mobility between countries.
- Quality and prices are constant; resources are fixed; no impact on income distribution.
- Relaxing these assumptions reveals complexities, but gains from trade generally persist.
Key Terms & Definitions
- Absolute Advantage — ability to produce a good using fewer resources than others.
- Comparative Advantage — ability to produce a good at a lower opportunity cost than others.
- Mercantilism — trade theory viewing world trade as zero-sum, favoring surpluses.
- Factors of Production — resources needed to make goods: land, labor, capital.
- Trade Surplus — when a country's exports exceed its imports.
Action Items / Next Steps
- Review trade theory diagrams/examples discussed in class.
- Read assigned textbook chapter on trade theories for more real-world examples.
- Prepare for discussion on the limitations of comparative advantage in the next session.