Module 15 krugman 1
Module 15
Gains from Trade
What’s New in the Fourth Edition?
• Updated cases
• Handouts to use in class
Module Objectives
• What is comparative advantage and why does it lead to international trade?
• What are the sources of comparative advantage?
Teaching Tips
Comparative Advantage and International Trade
Creating Student Interest
• Ask students to write down five imported goods they have purchased. If they need help, suggest that
they check the tags on their clothing!
• Ask students why they did not produce their own breakfast. Why did it make more sense to purchase
their breakfast from people who specialize in the production of breakfast foods? Ask students if they
Presenting the Material
• Students sometimes perceive that trade is unfair. Ask them if they think free trade is a good thing.
They might be good economists and say yes. They might say trade is unfair because we lose jobs;
Pitfalls
• How to calculate relative prices.
75 million phones sell for 37,500 trucks
Module Outline
Module 15 krugman 2
I. Comparative Advantage and International Trade
A. Production possibilities and comparative advantage, revisited
1. A country has a comparative advantage in producing a good if the opportunity cost of
producing the good is lower for that country than for other countries.
2. The Ricardian model of international trade analyzes international trade under the
assumption that opportunity costs are constant.
3. International trade allows each country to specialize in producing the goods for which
it has a comparative advantage. This leads to gains from trade in each country.
4. The text develops a numerical example of the production of phones and trucks by the
United States and China to review the theory of comparative advantage.
B. The gains from international trade
1. The text uses graphs and tables (Figure 8-3 and Table 8-2) to illustrate the gains from
trade. With trade, both countries are able to consume more of both goods.
2. The consumption choices of countries reflect both the preferences of its residents and
the relative prices in international markets.
3. Supply and demand determine the actual relative prices in international trade.
C. Comparative advantage versus absolute advantage
1. The United States imports phones from China even though workers in the United States
are more productive than workers in China, meaning it takes fewer labor hours to
produce the phones in the United States than in China.
2. Trade is based on comparative advantage and not absolute advantage. Labor
productivity in China in other industries is likely to be even lower than in the electronics
industry.
3. A country’s wage rates reflect its labor productivity. China’s wages are lower than the
United States’ wages because workers are less productive. This gives China a
D. Sources of comparative advantage
1. Differences in climate. For example, tropical countries grow and export tropical
products such as coffee, sugar, and bananas, whereas countries in temperate zones
export crops such as wheat and corn.
2. Differences in factor endowments.
a. According to the Heckscher–Ohlin model, a country has a comparative advantage
in a good whose production is intensive in the factors that are abundantly available
in that country.
Module 15 krugman 3
Case Studies in the Text
Economics in Action
How Hong Kong Lost Its Shirts—This EIA explains how Hong Kong was able to prosper over the last 60
years and achieve a level of per capita GDP that is very close to that of the United States.
Ask students the following questions:
1. In 1980, in what type of goods did Hong Kong have a comparative advantage?
Global Comparison
Productivity and Wages Around the World—Wages and productivity are used to explain the pauper labor
argument and sweatshop labor argument fallacies.
Web Resources
Module 15 krugman 4
Handout 15-1
Date_________ Name____________________________ Class________ Professor________________
Consider the following possibilities of production for the United States and Canada.
One possibility
The other possibility
United States
Wheat
30
0
Autos
0
60
Canada
Wheat
80
0
Autos
0
40
Who has an absolute advantage in producing autos? Who has an absolute advantage in producing
wheat?
Who has the comparative advantage in the production of autos? Who has the comparative advantage
in the production of wheat?
Complete the following table by indicating the opportunity cost of wheat in terms of autos and the
opportunity cost of autos in terms of wheat for both the United States and Canada.
Product
United States
(opportunity cost)
1 bushel of wheat
1 auto
What would be effective terms of trade for the United States and Canada?
Module 15 krugman 5
Answers:
Who has an absolute advantage in producing autos? Who has an absolute advantage in producing
wheat?
Who has comparative advantage in the production of autos? Who has comparative advantage in the
production of wheat?
Complete the following table by indicating the opportunity cost of wheat in terms of autos and the
opportunity cost of autos in terms of wheat for both the United States and Canada
Or use a table:
Product
United States
(opportunity cost)
Canada
(opportunity cost)
What would be effective terms of trade for the United States and Canada?
The United States and Canada will agree on the terms of trade between autos and wheat that meets the
following conditions: