International Business Chapter 2 United States Has The Highest Level Productivity And Enjoys The Highest Wage

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Similar to the home country, trade in the foreign country is also balanced. By specializing in the

production of cloth, Foreign produces 100 yards, 60 of which it keeps for consumption and the other 40

it exports to Home in exchange for 60 bushels of wheat. Note that the amount of cloth Foreign exports is

two findings are consistent with the Ricardian model, where the pattern of trade is determined by

comparative advantage and both countries gain from trade.

A very important third lesson can be inferred from the Ricardian model. We have just learned that prices

for the goods converge to a single equilibrium price. Is this also true for wages? Do wages converge to a

single value across trading partners? The Ricardian model does not predict this. Even though trading

Absolute Advantage Note that the because Home has an absolute advantage in both goods, Foreign

workers earn less than Home workers, as made evident by how much less they can purchase of either

good—1 yard of cloth or

bushels of wheat compared to Home’s ability to purchase

yards of cloth

or 4 bushels of wheat. Home workers can afford to purchase more of wheat and cloth than Foreign

Ricardian model predicts this very scenario.

APPLICATION

Labor Productivity and Wages

Using value-added per hour as the measure for labor productivity, we see from Figure 2-7 that there is a

relationship between labor productivity and wages. Of the seven countries presented, the United States

has the highest level of productivity and enjoys the highest wage, whereas Taiwan has the lowest level

of productivity and thus receives the lowest wage. Figure 2-8 shows the labor productivity and wages

over time for each of the seven countries. The graphs indicate a close connection between labor

productivity and wages, with both rising over time.

4 Solving for International Prices

Instead of assuming that the international relative price of wheat is between the two countries’ no-trade

Home Export Supply Curve We use panel (a) of Figure 2-9, which is a replica of Figure 2-5, to

construct the Home export supply curve, in which the vertical axis measures the relative price of wheat

and the horizontal axis measures the exports of wheat. The export supply curve of wheat is equal to zero

when the international relative price of wheat is below the home country’s no-trade price ratio (

When the international relative price of wheat is equal to the home country’s no-trade price ratio, the

prices of wheat increase.

Foreign Import Demand Curve Using the same reasoning, the import demand curve for wheat is equal

to zero when the international relative price of wheat is above the foreign no–trade relative price of

wheat. If the international relative price of wheat is equal to 1, Foreign could either consume all of the

wheat and cloth it produces on its own [points A* and A*′ in panels (a) and (b) of Figure 2-10,

downward-sloping import demand curve for wheat. The flat portion of the import demand is unique to

International Trade Equilibrium Combining the Home export supply curve and the Foreign import

demand curve gives the world market for wheat, as shown in Figure 2-11. The intersection of the world

The Terms of Trade This is defined as the price of a country’s exports divided by the price of its

imports. The home country’s terms of trade, defined by PW/PC, improve as the price of wheat increases

APPLICATION

The Terms of Trade for Primary Commodities

In 1950, economists Raúl Prebisch and Hans Singer hypothesized that over time, the price of primary

commodities such as agricultural products and minerals would decline relative to the price of

manufactured goods. The decline of primary commodities would lead to a worsening of the terms of

trade for developing countries, the source of most of these products. The three graphs in Figure 2-12

show that the relative price of primary commodities has increased, decreased, and remained roughly the

same over time, depending on the product traded.

5 Conclusion

The Ricardian model consists of the simple concept that the pattern of trade is determined by

comparative advantage. By exporting the good in which a country has the lowest opportunity cost

relative to producing another good, the country could benefit from participating in international trade by

TEACHING TIPS

Tip 1: Comparative Advantage

Comparative advantage is perhaps the most important concept in international trade. Therefore, it

warrants substantial treatment in this course. Ask students to break into groups or work on their own to

Tip 2: An Introduction to Trade Data

To familiarize students with international trade data and sources, have students explore the part of the

United States International Trade Commission website that accesses trade data

Tip 3: Individual Products, Trade Flows, and Comparative Advantage

Yet another way to engage students in empirical international trade is to ask them to look up specific

goods and the United States’ major trading partners. Have your class go to the website of the

Here, students can pick their own goods to investigate U.S. imports, exports, and trade balance. Ask

them to look up a good they expect the United States to have a comparative advantage or disadvantage

in and to test their beliefs with current data.

Harmonized System

Codes (HS Codes)

Product Description

880240

Airplanes and other aircraft, of an unladen weight

exceeding 15,000 kilograms

480300

Toilet or facial tissue stock, towel or napkin stock

and similar paper of a kind used for household or

sanitary purposes, cellulose wadding and webs

660110

Garden or similar umbrellas