Sunday, April 29, 2007

Free Trade discussion

Again, this is for after Test 2 but a number of economics blogs have been discussing free trade theory. Greg Mankiw has two posts on Free trade theory here and here.

Greg mentions The Ricardian Trade Model and the H-O model. The latter model is beyond the scope of this class, but since both are based on the principle of comparative advantage you can get the basic idea behind all free trade models by studying this counter-intuitive principle.

In economics, the theory of comparative advantage explains why it can be beneficial for two parties (countries, regions, individuals and so on) to trade if one has a lower relative cost of producing some good. What matters is not the absolute cost of production but the opportunity cost, which measures how much production of one good is reduced to produce one more unit of the other good

Essentially what comparative advantage allows countries to do is eliminate production inefficiences, increasing the total amount of output. The posts above discuss the distributions of benefits of free trade. Essentially there will always be winners and losers, but the winners gains will outweigh the losers losses.

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