Balance of Payments
As countries trade goods and services, financial capital flows to establish trade balances. Capital either flows out or in, which creates the country's current account balance. The record of these transactions is reflected over a period of time in what is known as the balance of payments. Read this page and focus on how flows of goods and services are closely connected to flows of capital.
Calculating Comparative Advantage
In the 1800s, the United States and Britain traded wheat and cloth. The following table shows the varying hours of labor per unit of output.
| Wheat (in bushels) | Cloth (in yards) | Relative labor cost of wheat (Pw/Pc) | Relative labor cost of cloth (Pc/Pw) | |
|---|---|---|---|---|
| United States | 8 | 9 | 8/9 | 9/8 |
| Britain | 4 | 3 | 4/3 | 3/4 |
Step 1. Observe from [link] that, in the United States, it takes eight hours to supply a bushel of
wheat and nine hours to supply a yard of cloth. In contrast, it takes four hours to supply a bushel of wheat and three hours to supply a yard of cloth in Britain.
Step 2. Recognize the difference between absolute advantage and comparative advantage. Britain has an absolute advantage (lowest cost) in each good, since it takes a lower amount of labor to make each good in Britain. Britain also has a comparative advantage in the production of cloth (lower opportunity cost in cloth (3/4 versus 9/8)). The United States has a comparative advantage in wheat production (lower opportunity cost of 8/9 versus 4/3).
Step 3. Determine the relative price of one good in terms of the other good. The price of wheat, in this example, is the amount of cloth you have to give up. To find this price, convert the hours per unit of wheat and cloth into units per hour. To do so, observe that in the United States it takes eight hours to make a bushel of wheat, so workers can process 1/8 of a bushel of wheat in an hour. It takes nine hours to make a yard of cloth in the United States, so workers can produce 1/9 of a yard of cloth in an hour. If you divide the amount of cloth (1/9 of a yard) by the amount of wheat you give up (1/8 of a bushel) in an hour, you find the price (8/9) of one good (wheat) in terms of the other (cloth).