Narrator: Listen to part of a lecture in an economics class.
Professor: Probably you’ve thought about why countries may decide to trade internationally, or not, for certain products. Some countries even put up barriers to try to limit trading—um, imposing import or export tariffs, for example, or setting quotas—to try to prevent job losses at home. Just about every economist I know would agree that these barriers are a bad idea. Current political trends, however, may suggest that many people feel otherwise.
Regardless, I hope I can convince you, future business leaders, of the value of trade—with a simple argument based on a very simple principle. And that principle is called the theory of comparative advantage. Note that it’s not really a theory—it’s more of a mathematical fact.
First, a little history. Adam Smith made reference, back in the eighteenth century, to the idea of absolute advantage. Now, this is a bit different—Smith said that if we can buy something more cheaply abroad than we can make it home, it makes sense for us to, um, basically… to pocket the difference by just buying the cheaper foreign product. Then, we can turn around and sell a product in that country where we have an advantage. So he’s looking at price differences on an absolute basis. But—what if, say, one economy is just much more efficient at producing everything? Should it just not trade at all?
No! Comparative advantage says that it should, in fact, trade… if it has a relative advantage in one product, and a relative disadvantage in another. So, here’s where I will attempt to explain this mathematically, using a very simple situation that I hope will be easy to understand.
Let’s say there are only two countries—Country X and Country Y—and there are only two products. Products that relate to one another—let’s say, socks and shoes. OK. Now, suppose Country X is much more advanced. Let’s say that in Country X, a worker can make 12 pairs of shoes, or 8 pairs of socks, in a day. By contrast, let’s say that a worker in Country Y can only make 3 pairs of shoes, or 4 pairs of socks, in a day. You would think that Country Y should just trade for both products with Country X, because both products should be cheaper to make in Country X. Is that right?
Well, actually… comparative advantage says that both of these countries can be made better off by trading, assuming they can do so cheaply—meaning shipping costs aren’t much of an issue. The reason is, Country X has a relative advantage in making shoes, and Country Y has a relative advantage in making socks. What do I mean? Well, Country X can make more shoes each day than it can make socks, and Country Y can make more socks than shoes.
So… the optimal outcome for both countries is for all the labor in Country X to make shoes, for all the labor in Country Y to make socks, and for them to trade with each other for the footwear they do not produce domestically. As long as they trade in a ratio that is in between Country X’s shoes-to-socks ratio and Country Y’s shoes-to-socks ratio, both countries will profit. Both!
So let’s do the math here. Assume they trade at a ratio of one-to-one: Country X exports one pair of shoes to Country Y in exchange for every pair of socks it imports. Assume that Country X has two workers and Country Y has eight workers—it makes the math easy. In Country X, if one worker makes shoes and one makes socks, it will have 12 pairs of shoes and 8 pairs of socks in a day. But if both workers make shoes, it will have 24 pairs of shoes. It can then trade 12 pairs of shoes and receive 12 pairs of socks. Now, Country X is left with 12 pairs of shoes, but instead of 8 pairs of socks, now it has 12!
Now, let’s focus on Country Y. It has eight workers, and if they are divided evenly between making socks and shoes, Country Y would have 12 pairs of shoes and 16 pairs of socks. But, if instead they all made socks, now Country Y would have 32 pairs of socks. Country Y can then trade 12 pairs of socks with Country X, receiving 12 pairs of shoes in return… and like magic, it now has 12 pairs of shoes but 20 pairs of socks instead of 16.
Um, so, both countries profited by specializing in their relative, or comparative, advantage, and trading with the other country. Even though one country was much more productive than the other at, um, making both products. This idea can be extended to more sophisticated examples, but the principle always holds—countries are better off by specializing in some products and exchanging for others, so long as a comparative advantage exists, trading costs are low, and there are no barriers to trade. I hope this proves to you that, while protecting jobs by restricting trade may be politically attractive, in the long run, trade barriers are harmful to both sides.
|
What is the talk primarily about? |
Gist-content. The lecture primarily focuses on comparative advantage, and a mathematical example explaining how it affects international trade decisions. |
|
| ✗ | A Why absolute advantage is a flawed framework for evaluating international trade |
The professor makes it clear that comparative advantage is the proper metric to use, but the lecture is not devoted to exposing flaws in absolute advantage. |
| ✗ | B Ways to restrict the expansion of international trade |
The professor is arguing against restricting international trade. |
| ✗ | C Lessons learned from history about manufacturing advantages in one country compared with another |
While the professor does mention the historical principle of absolute advantage, this is not the primary focus of the talk. |
| ✓ | D The theory of comparative advantage and why it supports international trade |
Correct. The professor focuses on comparative advantage, and uses a mathematical example to explain why comparative advantage implies that international trade is beneficial. |
|
According to the professor, under what circumstances should one country trade with another country? |
Detail. According to the lecture, the countries should trade whenever one country has a relative advantage at making one product over another product, relative to the other country (provided that trading costs are low). |
|
| ✗ | A When costs of trading abroad are high |
The opposite is true. Trade should be considered when such costs are low. |
| ✗ | B When one country is more productive generally than another |
This is called “absolute advantage,” and the professor explains why this should not be the basis for international trade decision-making. |
| ✗ | C When one country has significantly more labor power available than another |
This idea is not discussed in the lecture. |
| ✓ | D When one country can make a product more efficiently than another country, relative to a different product |
Correct. “Comparative advantage” states that when one country has a relative advantage in producing one product over another, relative to the production capabilities in a different country, those countries should trade. |
|
According to the professor, what is the main difference between absolute advantage and comparative advantage? |
Detail. The professor makes it clear that absolute advantage is simply one country producing a product more efficiently than another, while comparative advantage involves a country being relatively more efficient at producing one good than another good. |
|
| ✓ | A Comparative advantage involves the relative production efficiency in one country, compared with another country, at making different products. |
Correct. This is the definition of “comparative advantage.” |
| ✗ | B Comparative advantage involves the production efficiency in one country compared with another at making one specific product. |
This is the definition of “absolute advantage.” |
| ✗ | C Comparative advantage only holds when one country is more efficient at making several products than is another country. |
This is “absolute advantage” across multiple products, not “comparative advantage.” |
| ✗ | D Comparative advantage only holds when one country is more efficient at making at least one product than is another country. |
The example given by the professor shows the opposite. One country is more efficient at making both goods than is the other country, but trade would still benefit both countries. |
|
What does the professor imply about comparative advantage when there are more than two products available for trade? |
Inference. Near the end of the lecture, the professor mentions that there are more “sophisticated examples, but the principle always holds—countries are better off by specializing in some products and exchanging for others, so long as a comparative advantage exists, trading costs are low, and there are no barriers to trade.” |
|
| ✗ | A Countries will be more likely to not benefit from trade. |
This opposite is true. The more products there are that are available for trading, the more likely some form of comparative advantage exists. |
| ✓ | B Countries will still be able to benefit from international trade in most circumstances. |
Correct. This idea is precisely what is implied in the quote mentioned above. |
| ✗ | C Trading costs will be higher than when there are only two products available for trade. |
This idea is not mentioned or implied in the lecture. |
| ✗ | D Trading costs will be less important than when there are only two products available for trade. |
This idea is not mentioned or implied in the lecture. In fact, the professor even repeats the idea that benefit from trade may be contingent upon “trading costs [being] low.” |
|
What does the professor imply about the trade example given between Country X and Country Y? |
Inference. The professor discusses a scenario in which Country X should make shoes, Country Y should make socks, and the two countries should trade, even though Country X has an absolute advantage at making both products. |
|
| ✓ | A The trading ratio of socks-to-shoes can affect whether trading will be beneficial to both countries. |
Correct. The professor states: “As long as they trade in a ratio that is in between Country X’s shoes-to-socks ratio and Country Y’s shoes-to-socks ratio, both countries will profit.” The implication is that if the trading ratio is outside of that range, one or both countries may fail to gain from trade. |
| ✗ | B Both countries will benefit from trade irrespective of the cost of shipping socks and shoes to one another. |
The professor directly states that when there is comparative advantage, trading should occur “assuming [the countries] can do so cheaply—meaning shipping costs aren’t much of an issue.” This implies that if shipping costs are high, one or both countries may fail to benefit. |
| ✗ | C Only Country X will benefit from trade because it has an absolute advantage in production. |
The professor states that both countries will benefit. |
| ✗ | D Only Country Y will benefit from trade because it has an absolute disadvantage in production. |
The professor states that both countries will benefit. |
|
What is the professor’s viewpoint regarding trade protection? |
Speaker’s Attitude. The professor makes it clear that he feels trade barriers are harmful from an economic perspective. |
|
| ✗ | A Trade barriers should only be put in place if one country has an absolute advantage over another in production. |
This idea is not discussed in the lecture. |
| ✗ | B Trade protection is valuable in some circumstances—particularly to help people avoid losing their jobs to foreign workers. |
The professor does not agree with this sentiment, which is the rationale used by some countries for implementing trade restrictions. Instead, he argues that trade restrictions are harmful rather than helpful. |
| ✓ | C He believes that if two countries have economic reasons for trading with one another, trade barriers are harmful to both countries. |
Correct. At the end of the lecture the professor says “while protecting jobs by restricting trade may be politically attractive, in the long run, trade barriers are harmful to both sides.” |
| ✗ | D He believes that if two countries have economic reasons for trading with one another, trade barriers are harmful only to the country with an absolute advantage in production. |
On the contrary, at the end of the lecture, the professor says that “while protecting jobs may be politically attractive, in the long run, trade barriers are harmful to both sides.” |