A two-round in-class trading game on the principle of comparative advantage and the theory of reciprocal demand

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Abstract

This paper outlines a classroom trading game that explores equilibrium terms of trade using the principle of comparative advantage and theory of reciprocal demand. Students are divided into eight groups. Each group is assigned a country with hypothetical productivity and each country seeks its trading partner based on comparative advantage. Students simulate the trading of goods between countries with the objective of achieving the best possible terms of trade. The game encourages students to reflect on their learning of the principle of comparative advantage, consider improvements in trade terms through negotiation, and summarize the conditions for mutually beneficial terms of trade. The study contributes to the existing literature by extending the discussion beyond comparative advantage to incorporate mutually beneficial terms of trade as well as factors contributing to the distribution of trade gains.

Introduction

In 1800, David Ricardo developed the principle of comparative advantage to show how countries can leverage specialization and benefit from international trade. According to Ricardo, comparative advantage, determined by the difference in opportunity costs, is merely a basis for trade (Carbaugh, 2017).

Modern trade theory explains this using a production possibility schedule (PPS). For any particular trade between two countries, we can label the autarky points in the absence of trade, post-specialization production points, and post-trade consumption points on each country’s PPS to visualize the production and consumption gains.

The post-trade consumption points that a nation can achieve are obviously determined by the international terms of trade. It appears reasonable that a trade deal would be agreed upon by both trading partners if for each of them, the international terms of trade are more favorable than their respective domestic terms of trade, that is, the domestic opportunity cost between the goods. Simply put, mutually beneficial terms of trade should be within the outer limits of the terms of trade, which are determined by the two countries’ domestic trade terms.

However, a shortcoming of Ricardo’s principle of comparative advantage is its inability to determine the actual terms of trade. The best description that Ricardo could provide was only in terms of the outer limits within which the terms of trade would fall. John Stuart Mill improved upon the Ricardian theory by developing the theory of reciprocal demand. In his view, the actual terms of trade are determined by the relative strength of each country’s demand for the other country’s product. The production costs determine the outer limits of the terms of trade, while the reciprocal demand determines the actual terms of trade within these limits.

It is always challenging for students to understand mutually beneficial terms of trade and the theory of reciprocal demand.1 Durham et al. (2007) state that experiments may be useful tools for demonstrating complex concepts. A two-round trading game could improve students’ understanding of this basis for trade by labeling autarky, post-specialization production, and post-trade consumption points, as well as calculating the gains from production and consumption. More importantly, it could help students overcome learning challenges by simulating the trading of goods between countries and enabling negotiations between hypothetical trading partners.

Several classroom experiments have included elements of trade theory. More recent ones include Winchester (2006), which is a pencil-and-paper experiment that discusses the effects of tariffs, and Isgut et al. (2005) and Johnson (2010), both of which are based on computerized experiments that leverage the computer’s power to track trade information.

Some international trade experiments primarily focus on the application of comparative advantage. Stodder (1994) and Haupert (1996) demonstrated the gains from trade using hand-run experiments. In particular, Stodder (1994) showed the gains from trade by having students pair up to trade and record their gains based on their different comparative advantages. Haupert (1996) described trade gains by giving students a fixed allocation of inputs and a production function, as well as a consumption goal, and the opportunity to trade their output over a number of experimental trials. The experiment was designed so that students could achieve their consumption goals only by specializing in the production of the good in which they had a comparative advantage and then trading with other players. However, these two experiments could only demonstrate that both trading partners could realize trade gains by exploiting specialization and trade; they did not discuss the distribution of the gains from trade. The actual terms of trade, that is, the rate at which a country’s export product is traded for the other country’s export product, will directly determine the distribution of trade gains. Our study extends the discussion beyond comparative advantage to incorporate mutually beneficial terms of trade as well as factors contributing to the actual terms of trade or distribution of trade gains.

More closely related to this study is Chiang (2007), which illustrates the effects of asymmetric information and bargaining on the distribution of trade gains, and implies that negotiations play a critical role in this distribution. This study’s contribution is to show that mutually beneficial terms of trade as well as the theory of reciprocal demand are other factors that contribute to the distribution of gains. There are relatively few classroom experiments that use these concepts.

In addition, the use of this two-round in-class game compared with the traditional approach can be justified on several grounds. Several studies advocate using games to complement the traditional lecture approach (Bergstrom and Miller, 2000; Hester, 1991). Given their tangible nature, classroom experiments improve students’ understanding of abstract concepts (Oxoby, 2001). Games can also make learning interesting in that they mask the large amount of learning needed to play them successfully (Houser and DeLoach, 1998). As students have different learning styles, using a range of teaching methods improves the understanding of economics across various types of students (Becker and Watts, 1995, 1996). Students with high participation in classroom experiments experienced significantly greater gains in the Test of Understanding in College Economics (Emerson and Taylor, 2004). Moreover, the use of classroom experiments is shown to be a significant factor in the improvement of student attitudes toward the study of economics (Durham et al., 2007).

Another advantage of this game is the feedback that the instructor obtains on students’ understanding of the principle of comparative advantage and theory of reciprocal demand. In a traditional lecture scenario, the instructor assesses students’ learning based on an examination or quiz. The use of games provides instructors with immediate feedback on what students know and do not know, thereby allowing them to adjust their instructional strategies to meet learning objectives (Angelo and Cross, 1993). This can be achieved through performance assessments contained within the game that appraise whether trading pairs have established the correct trade directions and have achieved mutually beneficial terms of trade.

This game is suitable for introductory International Economics courses and for class sizes of 30–50 students. It is best played after students have learned the principle of comparative advantage; drawing a PPS; labeling autarky, post-specialization production, and post-trade consumption points; and calculating the production and consumption gains, but before discussions on mutually beneficial terms of trade and the theory of reciprocal demand. Approximately 45 min are required to introduce, play, and discuss the game.

Additionally, we conducted a survey regarding the effectiveness of this game among 179 players (in four different sections) of the learning game. The results show that engagement in the game has a clearly positive effect on learning. Both Hamari et al. (2016) and Ruggiero (2015) used survey instruments to measure the subjective experiences of students when playing educational games.

This paper is organized as follows: Section 2 shows the directions and key takeaways from the first and second rounds of the game; Section 3 reports the feedback from the student participants; and Section 4 concludes.

Section snippets

Pre-game considerations

In a normal two-hour lecture, the instructor should spend the first hour describing the basic concept of the principle of comparative advantage. In this stage, the terms of trade should be directly provided, and the instructor should emphasize the question of why the given terms of trade are mutually beneficial, specifically, that both countries are better off. Students should be informed that they will be participating in a hypothetical trading game with prizes to explore these concepts

General feedback from the students

Data for the effectiveness of this game were gathered by a survey (sample in Appendix C) of 179 players in four different sections of the learning game.

Before participating in the game, 78% of the students rated their knowledge of comparative advantage and terms of trade to be somewhat or fairly low. On the other hand, 81% of the students considered their knowledge of these topics to be somewhat or fairly high after participating in the game. More than 90% of the students agreed or strongly

Conclusion

After several years of huge trade deficits with China, U.S. President Trump has promised to boost the U.S. economy and create jobs by closing trade gaps. Most economists disagree with his anti-free trade policies. Referring to the basic theory of David Ricardo, both countries benefit through trade, even if one has a deficit.

Therefore, it is extremely important to find effective ways of illustrating and explaining the concept of comparative advantage. This paper describes a classroom trading

Funding

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Declarations of interest

None.

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