1.3 — Comparative Advantage

# 1.3 — Comparative Advantage
## ECON 324 • International Trade • Fall 2020
### Ryan Safner Assistant Professor of Economics <a href="mailto:safner@hood.edu">safner@hood.edu</a> <a href="https://github.com/ryansafner/tradeF20">ryansafner/tradeF20</a> <a href="https://tradeF20.classes.ryansafner.com"> tradeF20.classes.ryansafner.com</a>

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# The Origins of Exchange I

- .hi-purple[Resources are in the wrong place!]

- People have *better* uses of resources than they are currently being used!

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# The Origins of Exchange II

- .hi-purple[We have the same stuff but different preferences]

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![:scale 65%](../images/boxlunch.jpg)

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# The Origins of Exchange III

- .hi-purple[We have different stuff and/or different preferences]

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![:scale 50%](../images/3oranges.jpg)

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# Transaction Costs and Exchange I

.pull-left[
- But .hi[Transaction costs]!
  - .hi-purple[Search costs]: cost of finding trading partners
  - .hi-purple[Bargaining costs]: cost of reaching an agreement
  - .hi-purple[Enforcement costs]: **trust** between parties, cost of upholding agreement, dealing with unforeseen contingencies, punishing defection, using police and courts 
]

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# Transaction Costs and Exchange II

- Resources *cannot* be switched to higher-valued uses

- If others value goods higher than their current owners, resources are *inefficiently* allocated!
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# Transaction Costs and Exchange III

.pull-left[
- .hi[Markets] are institutions that facilitate voluntary *impersonal* exchange and reduce transaction costs

- There's a lot of institutions in the "bundle" we call "markets": 
  - Prices, profits and losses, property rights, rule of law, contract enforcement, dispute resolution, protection, trust

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# Transaction Costs and Exchange III

.pull-left[
- All of those things are *assumed* when we draw nice supply & demand graphs on the blackboard

- How do various *political institutions* enable these market institutions to succeed?
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# Comparative Advantage

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# Specialization

Adam Smith

1723-1790
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> "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy...If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage." (Book I, Chapter 2).
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.source[Smith, Adam, 1776, [*An Enquiry into the Nature and Causes of the Wealth of Nations*](https://www.econlib.org/library/Smith/smWN.html)]

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# Specialization in the Presence of Absolute Advantage

- She also claims to be able to iron a shirt better and faster than anyone else

- Should she iron her own shirts?

> “I don’t always do all of my own ironing, even though I wish that I could.”

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![:scale 70%](../images/marthstewartiron.jpg)
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# Specialization in the Presence of Absolute Advantage

.pull-left[
.smallest[
- Even in the presence of .hi[absolute advantage] (one party is more efficient at producing *all* goods), it still often is better for them to specialize
  - A high opportunity cost of producing everything

- Pay others to perform a task, or purchase a good, and specialize in producing goods where you have the .hi-purple[lowest opportunity cost]

- This is the principle of .hi[comparative advantage]
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.pull-right[
.center[
![](../images/absoluteadvantage.jpg)
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# Comparative Advantage

1915-2009

Economics Nobel 1970
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- Sanislaw Ulam once challenged Samuelson to “*name me one proposition in all of social sciences which is both true and non-trivial*”

- Samuelson’s answer: comparative advantage

> “That it is logically true need not be argued before a mathematician; that is is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them,”

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.source[Samuelson, Paul A, 1969, “The Way of an Economist,” in P.A. Samuelson, ed. *International Economic Relations: Proceedings of the Third Congress of the International Economic Association*, London: Macmillan, p.11]

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# Ricardian Comparative Advantage

David Ricardo

1772-1823
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> “To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the
same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.”
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.source[Ricardo, David, 1817, [*Principles of Political Economy and Taxation*](https://www.econlib.org/library/Ricardo/ricP.html?chapter_num=7#book-reader)]

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# Ricardian Comparative Advantage

David Ricardo

1772-1823
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- Sought to explain an apparent paradox: countries often produce & export goods they don’t seem to be “good at producing!”

- Answer: citizens of the importing country are *even better* at producing *something else* (in relative terms)
  - Worthwhile for the exporting country to buy this from abroad (with exports as payment)
]

.source[Ricardo, David, 1817, [*Principles of Political Economy and Taxation*](https://www.econlib.org/library/Smith/smWN.html)]

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