Chapter 2: Comparative Advantage and the Standard Trade Model
Chapter 2 Introduction
Learning Objectives
After reading this chapter, you should be able to
- Discuss the importance of economic theories and models.
- Explain the theories of absolute advantage and comparative advantage.
- Explain international trade using the production possibilities frontier and community indifference curves.
- Describe the effects of international trade on production, consumption, and product prices.
Think About It!
Video: Economic Models
Before reading this chapter, watch this video outlining the basic concept of economic models.
Source: Khan Academy. (2017, August 8). Economic models | basic economics concepts | AP macroeconomics and microeconomics | Khan Academy [Video]. YouTube. https://www.youtube.com/ watch?v=7n_Hf_UsW7I
Reflection Questions
Before we begin, we encourage you to reflect on the following questions:
- Do you agree that because models are simplifications of reality, they cannot help us understand real-world economic behaviour. Why or why not?
- In your view, what are some reasons why countries trade with each other?
- Can countries with limited resources and poor technology benefit from free trade?
- Can you identify some different ways in which countries can and do benefit from trade?
Introduction
In this chapter, we discuss the use of models in economic analysis as aids to understanding economic behaviour. While models help us to make decisions we must use them with care. Next, we distinguish the theory of absolute advantage from the theory of comparative advantage and show how the second improves on the first. From there, we identify how differences in the opportunity costs of production are the basic reason for countries to engage in international trade. With the help of the production possibilities frontier and community indifference curves, we show how countries benefit from trade by jointly producing a larger output and attaining higher consumption levels at lower average prices. While the economic well-being of participating countries improves with international trade, we recognize that not all groups within the economy necessarily benefit. Lastly, while initial differences in price between countries provide the primary motivation for trade, we explore several factors that influence such differences.
