International TradeTrade between China and Italy

◦China makes everything cheaper, faster, better why trade with Italy?

Continuing growth of international trade

Important theory in international trade:

Comparative Advantage

What is Comparative Advantage?You need to know the meaning of

two terms:1. opportunity cost2. absolute advantage

Opportunity Costthe opportunities given up in the

choice of one expenditure over others

If you had $50 to entertain yourself, and you could either go to an amusement park or buy two DVDs, which would you do?

What is the opportunity cost of selecting the amusement park? the two DVDs?

Absolute Advantagethe ability of a country to produce more

of a good or service than competitors, using the same amount of resources

theory no trade occurs

China has absolute advantage in car and computer production.

1 car 1 computer

U.S.

China

15 hours

5 hours

4 hours 2 hours

Comparative Advantagethe ability of a country to

produce a particular good or service at a lower opportunity cost than another country

theory trade is beneficial

Comparative Advantage

To make 1 car, the U.S. gives up 3 computers.

To make 1 car, China gives up 2 computers.China has a low opportunity cost; therefore,

China has the comparative advantage in car production.

1 car 1 computer

U.S.

China

15 hours

5 hours

4 hours 2 hours

15/5 =34/2 =2

Comparative Advantage

To make 1 computer, the U.S. gives up 1/3 of a car.

To make 1 computer, China gives up ½ of a car.The U.S. has a low opportunity cost; therefore,

the U.S. has the comparative advantage in computer production.

1 car 1 computer

U.S.

China

15 hours

5 hours

4 hours 2 hours

5/15 =1/32/4 =1/2

Comparative AdvantageChina can specialize in car

production.The U.S. can specialize in

computer production.

GAINS IN TRADE:◦China can import computers from

the U.S. and export cars.◦The U.S. can import cars from China

and export computers.