Managerial Economics Lecture twelve Standard theories of international competition Theory reality
Managerial Economics Lecture Twelve: Standard theories of international competition Theory & Reality…
An undisputed truth? Belief in superiority of free trade near universal amongst economists Basic proposition put by samuelson nordhaus: Simply put, trade promotes specialization, and specialization increases productivity. "(297 Argument essentially unchanged since Ricardo in 1817: Trade lets countries specialise in producing goods in which they have a comparative advantage Not absolute productivity relative to other country,but Comparative productivity with respect to own industries
An undisputed truth? • Belief in superiority of free trade near universal amongst economists • Basic proposition put by Samuelson & Nordhaus: – “Simply put, trade promotes specialization, and specialization increases productivity.” (297) • Argument essentially unchanged since Ricardo in 1817: – Trade lets countries specialise in producing goods in which they have a comparative advantage: • Not absolute productivity relative to other country, but • Comparative productivity with respect to own industries
Free Trade and specialisation Ricardo's Comparative Advantage Took case Mercantilists argued would mean rival( Portugal) would"defeat"England in open trade Portugal assumed better than England at producing everything Argued that England would still benefit from free trade The Model
Free Trade and Specialisation • Ricardo’s “Comparative Advantage” – Took case Mercantilists argued would mean rival (Portugal) would “defeat” England in open trade • Portugal assumed better than England at producing everything • Argued that England would still benefit from free trade – The Model:
Free Trade and specialisation Two countries producing 2 commodities Assume Portugal Absolutely more efficient at producing both wine and cloth Relatively more efficient at producing wine than cloth More of both wine and cloth produced if England specialises in cloth Portugal specialises in wine Countries trade surpluses and increase consumption of both goods in both countries
Free Trade and Specialisation • Two countries producing 2 commodities • Assume Portugal – Absolutely more efficient at producing both wine and cloth – Relatively more efficient at producing wine than cloth • More of both wine and cloth produced if – England specialises in cloth – Portugal specialises in wine • Countries trade surpluses and increase consumption of both goods in both countries
Comparative Advantage Portugal (per 1000 men) 90 men to produce x units of cloth 80 men to produce y units of wine can produce 11.1 units of cloth; or 12.5 units of wine; or any"straight line"combination of the two England(per 1000 men) 100 men to produce x units of cloth 120 men to produce y units of wine can produce 10 units cloth, 8.5 units of wine or any linear combination:
Comparative Advantage • Portugal (per 1000 men) – 90 men to produce x units of cloth – 80 men to produce y units of wine – can produce • 11.1 units of cloth; or • 12.5 units of wine; or • any “straight line” combination of the two • England (per 1000 men) – 100 men to produce x units of cloth – 120 men to produce y units of wine – can produce 10 units cloth, 8.5 units of wine, or any linear combination:
Comparative Advantage So with no trade: Portugal Max. 11.1 cloth, or 12.5 wine England Max 10 cloth, or 8 1/3 wine rade Portugal 12.5 wine, England 10 cloth Exchange surpluses, total output greater Putting Ricardo's arguments in a diagram
Comparative Advantage • So with no trade: – Portugal Max. 11.1 cloth, or 12.5 wine – England Max 10 cloth, or 8 1/3 wine • Trade – Portugal 12.5 wine, England 10 cloth – Exchange surpluses, total output greater • Putting Ricardo’s arguments in a diagram…
Comparative Advantage Trade: England produces only Cloth, Portugal only Wine; output higher Wine output with trade Wine output 000000 without trade Cloth output with trade Cloth Cloth output without trade
Comparative Advantage Wine Cloth Wine output without trade Cloth output without trade Cloth output with trade Wine output with trade Trade: England produces only Cloth, Portugal only Wine; output higher
Comparative Advantage Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically. "(Ricardo 1817) Clever logical argument aided repeal of Corn Laws Identical to modern economic belief (Ricardo's model is economics"one big trick") Show increase in output by reallocating static resources But behind Ricardo's rhetoric, a Realpolitik
Comparative Advantage • “Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically.” (Ricardo 1817) • Clever logical argument aided repeal of Corn Laws • Identical to modern economic belief – (Ricardo’s model is economics’ “one big trick”) • Show increase in output by reallocating static resources • But behind Ricardo’s rhetoric, a Realpolitik…
Ricardos Realpolitik It has been my endeavour to shew throughout this work that the rate of profits can never be increased but by a fall in wages, and that there can be no permanent fall of wages but in consequence of a fall of the necessaries on which wages are expended. If, therefore, by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise. "(Ricardo 1817) Ricardo's real interest not efficiency, but shift income from landlords to capitalists(workers irrelevant to Ricardo Real objective to increase rate of investment
Ricardo’s Realpolitik • “It has been my endeavour to shew throughout this work, that the rate of profits can never be increased but by a fall in wages, and that there can be no permanent fall of wages but in consequence of a fall of the necessaries on which wages are expended. If, therefore, by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise.” (Ricardo 1817) • Ricardo’s real interest not efficiency, but – shift income from landlords to capitalists (workers irrelevant to Ricardo) – Real objective to increase rate of investment
Modern Comparative Advantage If price of wheat falls Rents fa‖l Money wages fall(cheaper wheat)while real wages remain constant Increased profits Greater accumulation Objective: promote growth by redistributing income Neoclassical Heckschler-Ohlin-Samuelson trade mode Exclusively static Therefore ignores income distribution hence growth Issue Basic theory by Heckscher, Ohlin, Samuelson, Vanek Best shown using"Edgeworth Box"analysis
Modern Comparative Advantage • If price of wheat falls – Rents fall – Money wages fall (cheaper wheat) while real wages remain constant – Increased profits – Greater accumulation – Objective: promote growth by redistributing income • Neoclassical Heckschler-Ohlin-Samuelson trade model – Exclusively static – Therefore ignores income distribution & hence growth issue – Basic theory by Heckscher, Ohlin, Samuelson, Vanek – Best shown using “Edgeworth Box” analysis:
