Week 1 Introduction to World Trade: Absolute and Comparative
Advantage
Reinert Chapter 2 Absolute Advantage
“Absolute advantage refers to the possibility that, due to differences in supply conditions, one
country can produce a product at a lower price than another country.” (20)
Supply and Demand in a Domestic Market
“There are a number of properties of the supply and demand curves in Figure 2.1 that are important
to understand.” (20)
Supply curve Demand curve
Upward sloping (20) Downward sloping (21)
“changes in price are represented … as “changes in prices are represented … as
changes in quantity supplied.” (20) changes in quantity demanded.” (21)
Supply-side factors: input/factor prices and Demand-side factors: incomes and
technology (20) preferences (21)
Changes in supply-side factors “are Changes in demand-side factors “are
represented by shifts of the supply curve”, represented by shifts of the demand curve”,
that is, changes in supply (21) that is, changes in demand (21)
“… the intersection of the supply and demand curves in Figure 2.1 determines the equilibrium in the
domestic rice market. In this diagram, the equilibrium price is 𝑃𝐸 , and the equilibrium quantity is
𝑄𝐸 .” (21)
Absolute Advantage
In Figure 2.3. it is assumed “that demand conditions are exactly the same in both countries” meaning
that “there are no differences in preferences, incomes, or the way demand responds to price
changes in Vietnam and Japan”. (22)
“The reasons we make this simplifying demand-side assumption is that trade often arises due to
differences in supply conditions rather than in demand conditions. … [Next] we will assume that the
supply curve for Vietnam is farther to the right than the supply curve for Japan, which means that at
every price, Vietnam supplies more rice than Japan.” (22) Possible reasons for this:
“... Vietnam produces rice using technology superior to that of Japan so that labor productivity in
Vietnam is higher in Japan.” (22) → irrelevant possibility in this case
, “… the prices for inputs used in rice production are lower in Vietnam than in Japan. This, in turn,
could reflect the fact that Vietnam is more abundantly endowed with rice production factors
(available land and agricultural labor) than Japan.” (22) → relevant possibility for this case
“The intersections of the supply and demand curves [in Figure 2.3.] determine the equilibrium prices
of rice in the two markets. The two prices are recorded as 𝑃𝑉 and 𝑃 𝐽 in the figure. Because no trade
is involved, these two prices are known in international economics as autarky prices. Autarky is a
situation in which a country has no economic relationships with other countries.” (22) “In
international trade theory, this situation is interpreted as Vietnam having an absolute advantage in
the production of rice vis-à-vis Japan. This absolute advantage reflects the differences in supply
conditions in the two countries. The presence of absolute advantage makes international trade a
possibility.” (23)
International Trade
“Adam Smith (1937) stated the following: ‘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’. … How does this apply to our
example? If the two countries move out of autarky and begin to trade, the world price of rice 𝑃𝑊 will
be somewhere between the two autarky prices, as follows:” (23)
𝑃𝑉 < 𝑃𝑊 < 𝑃 𝐽
Figure 2.4. shows “the movement from autarky to trade”: (23)
Vietnam Japan
“… experiences an increase in the price of rice “… experiences a decrease in the price of rice to
to the world level (from 𝑃𝑉 to 𝑃𝑊 )” (23) the world level (from 𝑃 𝐽 to 𝑃𝑊 )” (23)
“Quantity supplied will increase” (23) “… quantity supplied will decrease” (23)
“… quantity demanded will decrease.” (23) “… quantity demanded will increase.” (23)
“The amount by which quantity supplied “The amount by which quantity demanded
exceeds quantity demanded in Vietnam at 𝑃𝑊 exceeds quantity supplied in Japan at 𝑃𝑊
constitutes its exports of rice, 𝐸 𝑉 .” (23) constitutes its imports of rice, 𝑍𝐽 .” (23)
,“The associations you should have in your mind from the preceding discussion are presented in
Figure 2.5. … Technological and factor characteristics determine a pattern of absolute advantage
between two countries. This pattern of absolute advantage, in turn, can generate a pattern of trade.”
(24)
“It is important to stress here that Figure 2.5 is only a preliminary look at international trade. In the
real world, international trade is actually determined by comparative advantage rather than absolute
advantage. This is why we use the word tendency in the far right-hand boxes of the figure.” (26)
“What ensures that the amount exported by Vietnam is the same as the amount imported by
Japan?” (26)
“… if 𝐸 𝑉 were smaller than 𝑍𝐽 , there would be excess demand or a shortage in the world market
for rice. … [followingly] excess demand causes the price to rise. As 𝑃𝑊 rose, exports of Vietnam
would increase and imports of Japan would decrease until the excess demand in the world
market disappeared.” (26)
“Similarly, if 𝐸 𝑉 were larger than 𝑍𝐽 , 𝑃𝑊 would fall to bring the world market back into
equilibrium.” (26)
, Gains From Trade
Consumer surplus: “For quantities between zero and 𝑄𝐸 , however, the willingness to pay is greater
than what consumers actually pay. That is, the height of the demand curve is greater than the market
price.” (30)
Producer surplus: “For quantities between zero and 𝑄𝐸 , however, the willingness to accept is less
than what the producers actually receive.” (30)
Figure 2.6:
“In … [Vietnam’s] movement from autarky to exporting in the rice market, producers experience
both an increase in price and an increase in quantity supplied along the supply curve. This should
be good for producers, and as you can see in Figure 2.6, there has been an increase in producer
surplus of area A + B … Consumers, on the other hand, experience an increase in price and a
decrease in quantity demanded along the demand curve. This should harm consumers[:] … there
has been a decrease in consumer surplus of area A.” (26) “For the economy as a whole, then,
there is a net welfare increase of area B. Vietnam gains from its entry into the world economy as
an exporter.” (27)
“In … [Japan’s] movement from autarky to importing in the rice market, producers experience a
decrease in price and a decrease in quantity supplied … This should harm these producers, and …
there has been a decrease in price and an increase in quantity demanded. These contribute to an
increase in consumer surplus of area C + D. … For the economy as a whole, then, there is a net
welfare increase of area D. Japan gains from its entry into the world economy as an importer.”
(27)
So, “moving from autarky to either importing or exporting involves a net increase in welfare for the
country involved. This net increase in welfare is known as the gains from trade.” (27)
Advantage
Reinert Chapter 2 Absolute Advantage
“Absolute advantage refers to the possibility that, due to differences in supply conditions, one
country can produce a product at a lower price than another country.” (20)
Supply and Demand in a Domestic Market
“There are a number of properties of the supply and demand curves in Figure 2.1 that are important
to understand.” (20)
Supply curve Demand curve
Upward sloping (20) Downward sloping (21)
“changes in price are represented … as “changes in prices are represented … as
changes in quantity supplied.” (20) changes in quantity demanded.” (21)
Supply-side factors: input/factor prices and Demand-side factors: incomes and
technology (20) preferences (21)
Changes in supply-side factors “are Changes in demand-side factors “are
represented by shifts of the supply curve”, represented by shifts of the demand curve”,
that is, changes in supply (21) that is, changes in demand (21)
“… the intersection of the supply and demand curves in Figure 2.1 determines the equilibrium in the
domestic rice market. In this diagram, the equilibrium price is 𝑃𝐸 , and the equilibrium quantity is
𝑄𝐸 .” (21)
Absolute Advantage
In Figure 2.3. it is assumed “that demand conditions are exactly the same in both countries” meaning
that “there are no differences in preferences, incomes, or the way demand responds to price
changes in Vietnam and Japan”. (22)
“The reasons we make this simplifying demand-side assumption is that trade often arises due to
differences in supply conditions rather than in demand conditions. … [Next] we will assume that the
supply curve for Vietnam is farther to the right than the supply curve for Japan, which means that at
every price, Vietnam supplies more rice than Japan.” (22) Possible reasons for this:
“... Vietnam produces rice using technology superior to that of Japan so that labor productivity in
Vietnam is higher in Japan.” (22) → irrelevant possibility in this case
, “… the prices for inputs used in rice production are lower in Vietnam than in Japan. This, in turn,
could reflect the fact that Vietnam is more abundantly endowed with rice production factors
(available land and agricultural labor) than Japan.” (22) → relevant possibility for this case
“The intersections of the supply and demand curves [in Figure 2.3.] determine the equilibrium prices
of rice in the two markets. The two prices are recorded as 𝑃𝑉 and 𝑃 𝐽 in the figure. Because no trade
is involved, these two prices are known in international economics as autarky prices. Autarky is a
situation in which a country has no economic relationships with other countries.” (22) “In
international trade theory, this situation is interpreted as Vietnam having an absolute advantage in
the production of rice vis-à-vis Japan. This absolute advantage reflects the differences in supply
conditions in the two countries. The presence of absolute advantage makes international trade a
possibility.” (23)
International Trade
“Adam Smith (1937) stated the following: ‘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’. … How does this apply to our
example? If the two countries move out of autarky and begin to trade, the world price of rice 𝑃𝑊 will
be somewhere between the two autarky prices, as follows:” (23)
𝑃𝑉 < 𝑃𝑊 < 𝑃 𝐽
Figure 2.4. shows “the movement from autarky to trade”: (23)
Vietnam Japan
“… experiences an increase in the price of rice “… experiences a decrease in the price of rice to
to the world level (from 𝑃𝑉 to 𝑃𝑊 )” (23) the world level (from 𝑃 𝐽 to 𝑃𝑊 )” (23)
“Quantity supplied will increase” (23) “… quantity supplied will decrease” (23)
“… quantity demanded will decrease.” (23) “… quantity demanded will increase.” (23)
“The amount by which quantity supplied “The amount by which quantity demanded
exceeds quantity demanded in Vietnam at 𝑃𝑊 exceeds quantity supplied in Japan at 𝑃𝑊
constitutes its exports of rice, 𝐸 𝑉 .” (23) constitutes its imports of rice, 𝑍𝐽 .” (23)
,“The associations you should have in your mind from the preceding discussion are presented in
Figure 2.5. … Technological and factor characteristics determine a pattern of absolute advantage
between two countries. This pattern of absolute advantage, in turn, can generate a pattern of trade.”
(24)
“It is important to stress here that Figure 2.5 is only a preliminary look at international trade. In the
real world, international trade is actually determined by comparative advantage rather than absolute
advantage. This is why we use the word tendency in the far right-hand boxes of the figure.” (26)
“What ensures that the amount exported by Vietnam is the same as the amount imported by
Japan?” (26)
“… if 𝐸 𝑉 were smaller than 𝑍𝐽 , there would be excess demand or a shortage in the world market
for rice. … [followingly] excess demand causes the price to rise. As 𝑃𝑊 rose, exports of Vietnam
would increase and imports of Japan would decrease until the excess demand in the world
market disappeared.” (26)
“Similarly, if 𝐸 𝑉 were larger than 𝑍𝐽 , 𝑃𝑊 would fall to bring the world market back into
equilibrium.” (26)
, Gains From Trade
Consumer surplus: “For quantities between zero and 𝑄𝐸 , however, the willingness to pay is greater
than what consumers actually pay. That is, the height of the demand curve is greater than the market
price.” (30)
Producer surplus: “For quantities between zero and 𝑄𝐸 , however, the willingness to accept is less
than what the producers actually receive.” (30)
Figure 2.6:
“In … [Vietnam’s] movement from autarky to exporting in the rice market, producers experience
both an increase in price and an increase in quantity supplied along the supply curve. This should
be good for producers, and as you can see in Figure 2.6, there has been an increase in producer
surplus of area A + B … Consumers, on the other hand, experience an increase in price and a
decrease in quantity demanded along the demand curve. This should harm consumers[:] … there
has been a decrease in consumer surplus of area A.” (26) “For the economy as a whole, then,
there is a net welfare increase of area B. Vietnam gains from its entry into the world economy as
an exporter.” (27)
“In … [Japan’s] movement from autarky to importing in the rice market, producers experience a
decrease in price and a decrease in quantity supplied … This should harm these producers, and …
there has been a decrease in price and an increase in quantity demanded. These contribute to an
increase in consumer surplus of area C + D. … For the economy as a whole, then, there is a net
welfare increase of area D. Japan gains from its entry into the world economy as an importer.”
(27)
So, “moving from autarky to either importing or exporting involves a net increase in welfare for the
country involved. This net increase in welfare is known as the gains from trade.” (27)
