Free trade according to the theory of Comparative Adventage

To see how this theory works imagine two countries, Alpha and Omega. Each country has 1,000 workers and can make two goods, computers and cars. Alpha’s economy is far more productive than Omega’s. To make a car, Alpha needs two workers, compared with Omega’s four. To make a computer, Alpha uses 10 workers, compared with Omega’s 100. If there is no trade, and in each country half the workers are in each industry, Alpha produces 250 cars and 50 computers and Omega produces 125 cars and 5 computers.

What if the two countries specialise? Although Alpha makes both cars and computers more efficiently than Omega (it has an absolute advantage), it has a bigger edge in computer making. So it now devotes most of its resources to that industry, employing 700 workers to make computers and only 300 to make cars. This raises computer output to 70 and cuts car production to 150 Omega switches entirely to cars, turning out 250.!!!

World output of both goods has risen. Both countries can consume more of both if they trade, but at what PRICE? Neither will want to import what it could make more cheaply at home. So Alpha will want at least 5 cars per computer, and Omega will not give up more than 25 cars per computer. Suppose the terms of trade are fixed at 12 cars per computer and 120 cars are exchanged for 10 computers. Then Alpha ends up with 270! cars and 60! computers, and Omega with 130! cars and 10! computers. Both are better off than they would be if they did not trade...However, Mexico is not better off now! in fact it has lost 1`300,000 jobs, just over the last 10 years! sad to say it, but that`s going to happen to Colombia as well! It´s a zero sum game.

By beckloud on May 14, 2007, 21:48 in Friendly Talkzone.

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