Macro chapter 2
What is absolute advantage? What is comparative advantage?
A country has an absolute advantage in producing a good if it uses fewer resources to produce that good than other countries. A country has a comparative advantage in producing a good if it has a lower opportunity cost of producing that good than other countries.
What are the two main sources of economic gains from intra-industry trade?
Intra-industry trade allows firms to specialize in different segments of markets (e.g. fuel-efficient cars, luxury cars) and even in producing specific parts of a larger item like cars. Learning takes place as people specialize in particular pieces of the value chain. In addition, specialization allows for economies of scale.
What is intra-industry trade?
Intra-industry trade refers to trade within the same industry from one country to another. For example, the United States both exports and imports cars.
Are the gains from international trade more likely to be relatively more important to large or small countries?
Small countries. Without trade, large countries with large internal markets will have room for more specialization and can have greater economies of scale.
Under what conditions does comparative advantage lead to gains from trade?
The gains will emerge if each country specializes in the good for which it has a comparative advantage and trades for other goods. The terms of trade must be such that they provide an improvement over domestic opportunity costs. For example, suppose the U.S. can produce two more tables if it produces one less cabinet. If trade allows us to produce a cabinet and trade it for more than two tables, we will be better off.
How does comparative advantage lead to gains from trade?
When countries (and individuals) specialize in their comparative advantage, productivity is higher and so total production is higher. The gains come from the higher production.
Is it possible to have a comparative advantage in the production of a good but not to have an absolute advantage? Explain.
Yes. Absolute advantage depends on who uses fewer resources to produce the good. Comparative advantage depends on who has a lower opportunity cost of producing the good. Even a country with an absolute advantage in everything is very unlikely to have a comparative advantage in everything.
What is splitting up the value chain?
Complex goods like cars and computers have many different parts. Splitting up the value chain means that firms specialize in producing particular parts rather than producing all of them.
What factors does Paul Krugman identify that supported the expansion of international trade in the 1800s?
Krugman argues that improved transportation led to a large increase in trade. Railroads and steamships lowered transportation costs significantly. With poor transportation, many trades do not occur because potential gains from trade are eaten up by transportation costs. When these costs are reduced, the trades become worthwhile.
