Riassunto Economics of global trade prof. Gianfreda

A ONE-FACTOR ECONOMY

To introduce the role of comparative advantage in determining the pattern of international trade, we begin by imagining that we are dealing with an economy—which we call Home—that has only one factor of production.

We imagine that only two goods, wine and cheese, are produced. The technology of Home’s economy can be summarized by labour productivity in each industry, expressed in terms of the number of hours of labour required to produce a pound of cheese or a gallon of wine. For example, it might require one hour of labour to produce a pound of cheese, two hours to produce a gallon of wine. Notice, by the way, that we’re defining unit labour requirements as the inverse of productivity—the more cheese or wine a worker can produce in an hour, the lower the unit labour requirement. For future reference, we define a LW and a LC as the unit labour requirements in wine and cheese production, respectively.

PRODUCTION POSSIBILITIES

Because any economy has limited resources, there are limits on what it can produce, and there are always trade-offs; to produce more of one good, the economy must sacrifice some production of another good. These trade-offs are illustrated graphically by a line (PF in Figure 3-1), which shows the maximum amount of wine that can be produced once the decision has been made to produce any given amount of cheese, and vice versa.

When there is only one factor of production, the production possibility frontier of an economy is simply a straight line. We can derive this line as follows: If QW is the economy's production of wine and QC its production of cheese, then the labour used in producing wine will be aLWQW, and the labour used in producing cheese will be aLCQC. The production possibility frontier is determined by the limits on the

Different mixes of goods the economy can produce. To determine what the economy will actually produce, however, we need to look at prices. Specifically, we need to know the relative price of the economy's two goods, that is, the price of one good in terms of the other.

In a competitive economy, supply decisions are determined by the attempts of individuals to maximize their earnings. In our simplified economy, since labour is the only factor of production, the supply of cheese and wine will be determined by the movement of labour to whichever sector pays the higher wage.

Suppose, once again, that it takes one hour of labour to produce a pound of cheese and two hours to produce a gallon of wine. Now suppose further that cheese sells for $4 a pound, while wine sells for $7 a gallon. What will workers produce? Well, if they produce cheese they can earn $4 an hour. (Bear in mind that since labour is the only input into production here, there are no profits, so workers receive the full value.

of their output.) On the other hand, if workers produce wine, they will earn only $3.50 an hour, because a $7 gallon of wine takes two hours to produce. So if cheese sells for $4 a pound while wine sells for $7 a gallon, workers will do better by producing cheese—and the economy as a whole will specialize in cheese production.

But what if cheese prices drop to $3 a pound? In that case workers can earn more by producing wine, and the economy will specialize in wine production instead.

More generally, let PC and PW be the prices of cheese and wine, respectively. It takes aLC person-hours to produce a pound of cheese; since there are no profits in our one-factor model, the hourly wage in the cheese sector will equal the value of what a worker can produce in an hour, PC / aLC. Since it takes aLW person-hours to produce a gallon of wine, the hourly wage rate in the wine sector will be PW / aLW. Wages in the cheese sector will be higher if PC / PW > aLC / aLW; wages in the wine sector will be

higher if PC /PW < aLC /aLW . Because everyone will want to work in whichever industry offers the higher wage, the economy will specialize in the production of cheese if PC/PW > aLC/aLW . On the other hand, it will specialize in the production of wine if PC/PW < aLC / aLW . Only when PC / PW is equal to aLC / aLW will both goods be produced.

What is the significance of the number aLC / aLW ? We saw in the previous section that it is the opportunity cost of cheese in terms of wine. We have therefore just derived a crucial proposition about the relationship between prices and production: The economy will specialize in the production of cheese if the relative price of cheese exceeds its opportunity cost in terms of wine; it will specialize in the production of wine if the relative price of cheese is less than its opportunity cost in terms of wine.

In the absence of international trade, Home would have to produce both goods for itself. But it will produce both goods only if the relative

The price of cheese is just equal to its opportunity cost. Since opportunity cost equals the ratio of unit labour requirements in cheese and wine, we can summarize the determination of prices in the absence of international trade with a simple labour theory of value: In the absence of international trade, the relative prices of goods are equal to their relative unit labour requirements.

TRADE IN A ONE-FACTOR WORLD

To describe the pattern and effects of trade between two countries when each country has only one factor of production is simple. Yet the implications of this analysis can be surprising. Indeed, to those who have not thought about international trade, many of these implications seem to conflict with common sense. Even this simplest of trade models can offer some important guidance on real-world issues, such as what constitutes fair international competition and fair international exchange.

Before we get to these issues, however, let us get the model stated. Suppose that there are two countries.

One of them we again call Home and the other we call Foreign. Each of these countries has one factor of production (labour) and can produce two goods, wine and cheese. As before, we denote Home's labour force by L and Home's unit labour requirements in wine and cheese production by a_LW and a_LC, respectively. For Foreign we will use a convenient notation throughout this book: When we refer to some aspect of Foreign, we will use the same symbol that we use for Home, but with an asterisk. Thus Foreign's labour force will be denoted by L*, Foreign's unit labour requirements in wine and cheese will be denoted by a_LW* and a_LC*, respectively, and so on. In general, the unit labour requirements can follow any pattern. For example, Home could be less productive than Foreign in wine but more productive in cheese, or vice versa. For the moment, we make only one arbitrary assumption: that

In words, we are assuming that the ratio of the labour required to produce a pound of cheese to that of wine is the same in both countries.

The unit labour requirement to produce a gallon of wine is lower in Home than it is in Foreign. More briefly still, we are saying that Home's relative productivity in cheese is higher than it is in wine. But remember that the ratio of unit labour requirements is equal to the opportunity cost of cheese in terms of wine; and remember also that we defined comparative advantage precisely in terms of such opportunity costs. So the assumption about relative productivities embodied in equations (3-2) and (3-3) amounts to saying that Home has a comparative advantage in cheese.

One point should be noted immediately: The condition under which Home has this comparative advantage involves all four unit labour requirements, not just two. You might think that to determine who will produce cheese, all you need to do is compare the two countries' unit labour requirements in cheese production. Home labour is more efficient than Foreign in producing cheese. When one country can produce a unit of a good with

When a country can produce a good with less labor than another country, we say that the first country has an advantage in producing that good. In our example, Home has an absolute advantage in producing cheese.

When the production possibility frontier is a straight line, the opportunity cost of a pound of cheese in terms of wine is constant. As we saw in the previous section, this opportunity cost is defined as the number of gallons of wine the economy would have to give up in order to produce an extra pound of cheese. In this case, to produce another pound would require aLC person-hours. Each of these person-hours could in turn have been used to produce 1/aLW gallons of wine. Thus the opportunity cost of cheese in terms of wine is aLC/aLW. For example, if it takes one person-hour to make a pound of cheese and two hours to produce a gallon of wine, the opportunity cost of each pound of cheese is half a gallon of wine. As Figure 3-1 shows, this opportunity cost is equal to the absolute value of the slope of the production

possibility frontier.

THE PRODUCTION POSSIBILITY FRONTIER

L=1,000 hours.

 a = 1 hours/lb, so 1 hour of labour produces one pound of cheese in the home country.

 LCa = 2 hours/gallon, so 2 hours of labour produces one gallon of wine in the home country.

 LWMaximum cheese production is 1,000 pounds.

 Maximum wine production is 500 gallons

Notation: ▪- aLC = number of hours of labour required to produce one unit of cheese. aLW = number of hoursof labour required to produce one unit of wine.- L = total supply of labour (for both goods).- QW = quantity of wine produced.- QC = quantity of cheese produced. Based on that, we can write: ▪- QW x aLW = total amount of hours of labour for the production of wine. QC x aLC = totalamount of hours of labour for the production of cheese.

63 - production possibility frontier.

The line PF is the It shows the maximum amount of cheese the home countrycan produce given any production of wine, and vice versa.

If I produce a quantity of wine and

Cheese that is on the production possibility frontier, it means I use all the available hours of labour.