David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 28 International trade
Conversely, the UK has the largest comparative advantage in making shoes, the good in which UK
producers are most efficient relative to US producers. As we move to the left, the comparative advantage of
the UK declines; US producers become increasingly efficient relative to UK producers.
The US has an absolute advantage in producing computers, cars, TVs and textiles. The UK has an absolute
advantage in producing glass and shoes. Nevertheless, absolute advantage plays no direct part in the
analysis. Comparative advantage is what counts.
The equilibrium exchange rate occurs at some intermediate level that just balances the value of trade
between the two countries. Essentially, the level of the exchange rate takes care of the overall level of
absolute advantage, leaving comparative advantage to determine trade patterns.
Different capital-labour ratios
Comparative advantage need not depend on technology differences. It may also reflect different factor
supplies. Consider the UK and China. The UK has more capital per worker than China. Even though
China's vast size may mean that it has absolutely more capital than the UK, the UK has relatively more
capital than China.
What does this imply about the relative price of hiring labour and capital in the two countries? With more
capital per worker, the marginal product oflabour is higher in the UK. This makes real wages higher in the
UK than in China. Conversely, the number of workers per unit of capital is lower in the UK than in China.
The marginal product of capital and the rental of capital will tend to be lower in the UK, where machinery
is relatively plentiful, than in China, where machinery is relatively scarce. Because the UK is endowed with
more capital relative to labour than China, the cost of using labour relative to capital is higher in the UK
than in China.
Relative costs of using inputs affect the relative price of the goods they produce. Goods made by labourintensive
methods cost relatively more to make in the UK than in China. Suppose car production is capital
intensive with sophisticated assembly lines, but textile production is labour intensive with detailed tasks
best done by hand. The price of cars relative to textiles is lower in the UK than in China.
Hence, a relatively abundant supply or endowment of one factor of production tends to make the cost of
renting that factor relatively cheap. Goods that use that factor relatively intensively are thus relatively
cheap. In these goods the country has a comparative advantage. Thus the UK, relatively generously supplied
with capital relative to labour, exports capital-intensive cars to China. China, relatively well endowed with
labour, should export labour-intensive textiles to the UK. Differences in relative factor supply are an
important explanation for comparative advantage and the pattern of international trade.
Figure 28.1 supports this analysis. It emphasizes skills, or human capital, rather than physical capital,
although the two are usually correlated. Countries with scarce land but abundant skills have high shares of
manufactures in their exports. Countries with lots ofland but few skills typically export raw materials. The
figure also shows regional averages. Africa lies at one end, the industrial countries at the other.
We now have two explanations for comparative advantage or international differences in relative production
costs. The first is the Ricardian explanation - international differences in technology that cause differences
in relative physical productivity and relative unit labour requirements. Second, even if countries have
access to the same technology, the domestic relative price of goods may differ across countries because the
relative cost of renting factor inputs differs across countries. Where a factor is in relatively abundant supply,
goods that use that factor relatively intensively are likely to be relatively cheaper than in other countries. 3
3 Strictly speaking, this explains differences in relative prices before countries start trading. Export demand may bid up the
relative price of the good until relative prices are equalized across countries. This explains why trade is not infinite. Nevertheless,
beginning from no trade, comparative advantage explains which goods the country then exports and which it imports.
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