Lecture 3: Comparative
Advantage
An Introduction to International
Economics: New Perspectives on the
World Economy
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.1: The Production Possibility
Frontier
Kenneth A. Reinert, Cambridge University
Press 2012
Review of PPF
PPFs depict the combinations of output of two
goods (rice and motorcycles) that the economy
(Vietnam or Japan) can produce given its
available resources and technology
In Figure 3.6 we have the following points:
A: full employment on the PPF
B: full employment on the PPF
C: not feasible
D: feasible with unemployed resources
Kenneth A. Reinert, Cambridge University
Press 2012
Comparative Advantage
As incomes increases in Vietnam, consumers
began to think about a motorcycle
In this lecture, we will place motorcycles
alongside rice so that you can begin to
understand
Concept of comparative advantage and its role in
generating patterns of trade among the countries of the
world
Requires the use of a production possibilities frontier
Kenneth A. Reinert, Cambridge University
Press 2012
Autarky and Comparative Advantage
Consider again Vietnam and Japan
Both of these countries produce two goodsrice
and motorcycles
Assume that demand for rice and motorcycles in
both Vietnam and Japan is such that these two
goods are consumed in the same, fixed proportions
This assumption is depicted in Figure 3.2
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.2: Demand Diagonals in
Vietnam and Japan
Kenneth A. Reinert, Cambridge University
Press 2012
Production Possibilities Frontier
Assumptions
Resource or technology conditions in Vietnam give it a
PPF that is biased towards rice
Resource or technology conditions in Japan give it a
PPF that is biased towards motorcycles
Vietnam might have superior technology in rice production,
and Japan might have superior technology in motorcycle
production or
Vietnam might be better endowed in rice production factors
(land and labor), and Japan might be better endowed in
motorcycles production factors (physical capital)
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.3: Demand and PPFs in
Vietnam and Japan
Kenneth A. Reinert, Cambridge University
Press 2012
Production Possibilities Frontier
In a system of freely operating markets and full
employment of production factors, opportunity
costs are fully reflected in relative prices
The slope of a PPF where demand diagonal crosses it is
the relative price of rice, or P P
This is shown in Figure 3.4 by drawing the tangent lines to
the PPFs at the point where the demand lines cross them,
points A
Points A in the two PPFs in Figures 3.4 represent two
countries under autarky.
R
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.4: Relative Prices in Vietnam
and Japan under Autarky
Kenneth A. Reinert, Cambridge University
Press 2012
Autarky and Comparative Advantage
The tangency line giving relative prices is flatter in Vietnam
than in Japan
The opportunity cost of rice is lower in Vietnam than in Japan
In other words, under autarky, P P P P
Or, the relative price of rice is lower in Vietnam than in Japan
V
What we have here is an expression of the pattern of
comparative advantage
Differences in economy-wide supply conditions cause differences in
relative autarky prices and hence a pattern of comparative advantage
Note that comparative advantage involves four prices rather
than two prices as in absolute advantage
Consequently, a country can have comparative advantage in a good in
which it has an absolute disadvantage
Kenneth A. Reinert, Cambridge University
Press 2012
International Trade
If Vietnam and Japan abandon autarky in favor of
trade, the world relative price of rice will lie
somewhere between the two autarky price ratios
This situation is depicted in Figure 3.5
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.5: Autarky and Comparative
Advantage in Vietnam and Japan
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.5 Discussion
These lines are steeper than the autarky price line in
Vietnam and flatter than the autarky price line in Japan
The tangencies of these world price lines with the PPFs
determine the new production points in Vietnam and
Japan
In Vietnam, the movement along the PPF from A to B involves an
increase in production of rice, while in Japan, this movement
involves an increase in production of motorcycles
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.5 Discussion (cont.)
Moving from autarky to trade restructures an economys
production towards the good in which country has a
comparative advantage
Consumption points for Vietnam and Japan must be
along our diagonal demand linesoccur where the
dashed world price lines intersect demand lines
Both consumption and production must respect world prices
both B and C must be on world price lines
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.6: Trade between Vietnam and
Japan
Kenneth A. Reinert, Cambridge University
Press 2012
Figure 3.6 Discussion
In Vietnam, production of rice exceeds consumption of rice,
and the difference is exported
Production of motorcycles, however, falls short
consumption of motorcycles, and this shortfall is imported
In Japan, production of motorcycles exceeds consumption of
motorcycles, and the difference is exported
Production of rice falls short of production, and this shortfall is
imported
A pattern of comparative advantage gives rise to a
complementary pattern of trade
Kenneth A. Reinert, Cambridge University
Press 2012
of
International Trade
Absolute advantage concept can leave the impression
that a country could lack an advantage in anything
An absolute disadvantage in a product does not preclude
having a comparative advantage in that product
Therefore have nothing to export
Vietnam could have an absolute disadvantage in rice, but still
export rice because of its comparative advantage
Comparative advantage is a more powerful concept than
absolute advantage
Perhaps the most central concept in international economics
Kenneth A. Reinert, Cambridge University
Press 2012
Gains from Trade
Should a country actually give up autarky in favor of
importing and exporting?
Figure 3.5 shows that the movement from autarky to
trade (points A to C) increases consumption of both
rice and motorcycles
Increased consumption of both goods implies that
economic welfare has increased
Vietnam and Japan have experienced gains from trade
based on comparative advantage
Kenneth A. Reinert, Cambridge University
Press 2012
Gains from Trade Caveats
Gains from trade occur for the country as a whole
Does not mean that every individual or group within the
country benefits
Good reasons to expect that there will be groups that lose from
increased trade
These groups will oppose increased trade despite the overall gains to
their country
Kenneth A. Reinert, Cambridge University
Press 2012
Appendix
Relative price determination in a PPF
Step 1: The slope of the PPF (QM/QR) is the opportunity cost of the good
on the horizontal axis, rice. It indicates how many motorcycles must be given
up to produce an additional unit of rice
Step 2: In a perfectly competitive market system when resources are fully
employed and firms maximize profits, the opportunity costs are fully reflected
in relative prices. The relative price of rice, horizontal axis, is (PM/PR)
Step 3: A tangent line to the PPF shares the same slope of the PPF,
(QM/QR)
Step 4: Given steps 1,2,3 we can see that a tangent line to the PPF has a
slope equal to the relative price of the good on the horizontal axis, (PM/PR)
Kenneth A. Reinert, Cambridge University
Press 2012
