Hi guys. Welcome back to
Global Business Environment.
We are in module five, this is part three of module five,
in which we've been trying to answer the question,
what are the gains or benefits from trade between countries,
and we've talked about the history of trade, and
the anti free trade philosophies which dominated much of the 15, 16 and 1700s.
And we talked about that philosophy being called mercantilism, and
it wasn't until a couple of economists, philosophers Adam Smith and
David Ricardo came out with some very powerful quantifiable examples that
the world started to shift its opinion about the benefits from trade.
And these and other economists were able to demonstrate to policy makers,
governments, citizens, business people, that there could be a win-win,
situation when trade occurred, that both sides could benefit, and they demonstrated
this using somewhat artificial examples artificial because of the assumptions.
But they were nonethe,
nevertheless very powerful at convincing people of these potential benefits.
And so, let me go through this example with you and
the first idea that came forward is known as absolute advantage.
In part four we'll look at a sister concept comparative advantage, but
absolute advantage was the first one that was brought forth and
the assumptions in this example of absolute advantage are that
there are only two countries in the world.
That's obviously not real, there are more than two countries for
the purposes of our example we'll use Mexico and India.
And there's also an assumption that each country has the exact same
number of resources at their disposal and
there's only one resource needed to make any type of products.
So each country, Mexico, each country, Mexico and India are in our example, have
has 1,000 units of this resource, this generic productive resource, and
where they differ is in their ability to utilize their resources to make products.
And we're going to assume that there are only two products in the world.
Obviously not real an artificial setting.
And in our case we're going to talk about there being smartphones and
motorcycles, and each country is going to have an advantage or
more specifically, an absolute advantage.
They will have this advantage in production in other words they'll be more
productive, more efficient it's less costly,
it's cheaper for them to make one of the products or the other.
In this example it will take India 20 resources
of their thousand to make one of these smartphones and
it will take Mexico only 10 of these resources to make the smartphone.
So India is much less productive than Mexico is, in fact you might say that
Mexico is twice as efficient as India is at making smartphones.
When we look at motorcycles, the reverse is true, and
in fact it's a bigger gap Mexico is much less efficient, it's,
it's not as good at making motorcycles compared to India, it takes India
only 20 units of these resources to make one motorcycle, and it takes Mexico 50.
So India is more than twice as productive or
efficient at making motorcycles than Mexico.
And so what happens it's,
if each of these countries decide to buy into the ideas of mercantilism and
isolate themselves as two separate islands and don't trade, don't interact?
What if each of them decides to dedicate 50%
of its resources to the production of each of these products?
How much will they produce?
You can see here, on this second line that Mexico will end up,
because of their advantage, their absolute advantage in making smartphones with 50,
if they use 500 of their resources at 10 each, they can make 50 smartphones, and
India will be able to make 20 only 25.
As we saw the difference here, in their ability to make motorcycles,
Mexico will only make 10 motorcycles, whereas India will make 25 and
the total world consumption of each of these goods is right here.
This is the production and consumption.
This is what society in each of these countries gets to utilize.
And, so they're, they're cut off from each other.
You might say to be a little bit silly, that Mexico can talk a lot.