Ch2-3 Summary An Introduction to International Economics, ISBN: 9781108455169 ECON0007 - The World Economy (ECON0007)
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Course
ECON0007 - The World Economy (ECON0007)
Institution
University College London (UCL)
Book
An Introduction to International Economics
This is a summary of the readings we completed for World Economy in week 1, which covered Chapters 2-3 of the Reinert (2020): An Introduction to International Economics, ISBN: 5169
Reinert (2020): An Introduction to International Economics
Chapter 2: Absolute Advantage
International International trade in goods and services – one of the main features of globalisation.
trade
Why does a country export / import a particular good or service?
Absolute advantage – historical explanation.
Comparative advantage – replaced absolute advantage as the explanation.
Definitions Absolute advantage: the possibility that, because of differences in supply conditions, one
country can produce a product at a lower price (or resources/inputs) than another country.
Comparative advantage: a situation in which a country’s relative autarkic price ratio of one
good in terms of another is lower than that of other countries in the world.
Gains from trade: advantages that accrue to a country from engaging in importing and
exporting relationships.
From an absolute advantage framework, gains from trade are identified as a net gain
between consumer and producer effects.
In a comparative advantage framework, gains from trade are identified as an increase
in consumption of all goods.
Mercantilism A sort of zero-sum economic philosophy in which wealth was characterised as being equivalent
to stocks of precious metal, usually held in royal treasuries.
Adam Smith disputed this, substituting a concept of wealth as the broad-based consumption of
goods and services.
One way of doing this was through his idea of absolute advantage, showing the possibility
of international trade being mutually beneficial rather than zero-sum.
Concept of Example 1:
absolute Suppose there is just one resource: labour.
advantage Amount of labour used to produce a unit of rice: aR.
Suppose there are only two countries: Vietnam and Japan.
V
Amount of labour used to produce a unit of rice in Vietnam: a R .
J
Amount of labour used to produce a unit of rice in Japan: a R .
V J
Principle of absolute advantage: if a R <a R , then Vietnam has an absolute advantage
in the production of rice relative to Japan. So, Vietnam should export rice to Japan, and
Japan should import rice from Vietnam.
Example 2:
First robots made in the United States ...
… presented the robots to Japanese scientists and businessmen in 19…
Japan then imported its first robots in … and began creating their own robots in …
Japan’s advantage in robot production was due faster innovation times as firms
imitated innovations quickly.
There is a high degree of competition in Japan’s industrial robot industry (less than 10
firms in 1968 and 150 in 2000).
Intra-firm diffusion: firms began producing robots for their own use.
Labour shortages also promoted the use of robots. ½ of the world’s industrial robots
are installed in Japan (1 robot for every 36 employees in Japan vs. 1 for every 250 US
manufacturing employees).
The principle of absolute advantage is a policy suggestion that countries should import goods
from other countries where they are produced more efficiently and deploy scarce resources to
produce goods that they can produce more efficiently.
Remember that the pattern of trade implied by absolute advantage is one determined by
technological considerations.
However, it turns out that actual patterns of trade are determined by comparative advantage.
Applying the Principle of absolute advantage:
absolute
V J
If a R <a R , then Vietnam has an absolute advantage in the production of rice relative to
advantage Japan.
, model within a R refers to the amount of labour.
the supply and Therefore, absolute advantage is characterised by the supply side of economics.
demand model The same case is for comparative advantage.
Since they are supply side principles, we simplify the demand side by assuming that demand
conditions are exactly the same in both countries, i.e., there are no differences in preferences,
incomes, or PED.
The pattern of absolute advantage we are considering here suggests that Vietnam has better
technology in producing rice than Japan; it uses less labour per unit of output than Japan.
Implications on the supply side of the Vietnamese and Japanese rice markets:
We assume that the supply curve for Vietnam is farther to the right than the supply
curve for Japan.
This means that, at every price, Vietnam’s quantity supplied is greater than Japan’s.
The two equilibrium prices are recorded as PV and PJ .
Since no trade is involved, these two prices are autarky prices.
Autarky prices: a situation of national self-sufficiency in which a country does not import or
export.
The autarky price of rice is lower in Vietnam than in Japan: PV < P J .
If Japan and Vietnam abandoned autarky and began to trade, the world price of rice PW
will be somewhere between the two autarky prices: PV < PW < P J .
o In the movement from autarky to trade, Vietnam experiences an increase in the
price of rice to the world level ( PV → PW ).
o Quantity supplied increases, while quantity demanded decreases.
o The amount by which quantity supplied exceeds quantity demanded in Vietnam
at PW constitutes its exports of rice, EV .
o In Japan, there is a decrease in the price of rice to the world level ( PJ → P W ).
o Quantity supplied decreases, while quantity demanded increases.
o The amount by which quantity demanded exceeds quantity supplied in Japan at
W J
P constitutes its imports of rice, Z .
o The country that has an absolute advantage (Vietnam) expands its quantity
supplied and exports the good in question, while the trading partner (Japan)
contracts its quantity supplied and imports the good.
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