2 2 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No.
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● Why Trade?
● International versus Intranational Trade
● The Law of Comparative Advantage
● Tariffs, Quotas, and Other Interferences with Trade
● Guest Lecture: Turkey's Comparative Advantage in Trade
● Why Trade?
● International versus Intranational Trade
● The Law of Comparative Advantage
● Tariffs, Quotas, and Other Interferences with Trade
● Guest Lecture: Turkey's Comparative Advantage in Trade
ContentsContents
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Why Trade?Why Trade?
● Reasons countries benefit from foreign trade♦ They can import resources they lack at home.
♦ They can import goods for which they are a relatively inefficient producer.
♦ Specialization sometimes permits economies of large-scale production.
● Reasons countries benefit from foreign trade♦ They can import resources they lack at home.
♦ They can import goods for which they are a relatively inefficient producer.
♦ Specialization sometimes permits economies of large-scale production.
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● Mutual Gains from Trade♦ When trade is voluntary:
■Both sides must expect to gain from it■Otherwise, they would not trade
● Mutual Gains from Trade♦ When trade is voluntary:
■Both sides must expect to gain from it■Otherwise, they would not trade
Why Trade?Why Trade?
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● Why international trade is studied separately:♦ Countries are governed by separate
governments♦ International trade involves the exchange of
national currencies♦ Labor and capital are less mobile
internationally than they typically are within a country
● Why international trade is studied separately:♦ Countries are governed by separate
governments♦ International trade involves the exchange of
national currencies♦ Labor and capital are less mobile
internationally than they typically are within a country
International versus Intranational TradeInternational versus Intranational Trade
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Absolute AdvantageAbsolute Advantage
● One country has an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources than can the other country.
● One country has an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources than can the other country.
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● One country has a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country.
● Less inefficiently = with lower opportunity costs
● One country has a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country.
● Less inefficiently = with lower opportunity costs
The Law of Comparative AdvantageThe Law of Comparative Advantage
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The Law of Comparative AdvantageThe Law of Comparative Advantage
● The law of comparative advantage applies even if one country is at an absolute disadvantage relative to another country in the production of every good.
● Both countries gain from trade even if one of them is more efficient than the other in producing everything.
● The law of comparative advantage applies even if one country is at an absolute disadvantage relative to another country in the production of every good.
● Both countries gain from trade even if one of them is more efficient than the other in producing everything.
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The Law of Comparative AdvantageThe Law of Comparative Advantage
● The Arithmetic of Comparative Advantage♦ When countries differ in the relative efficiency
with which they produce different goods: ■Both world output and the welfare of each country
can be increased if: ● Each country specializes in producing the goods for
which it has a relative advantage;
● And then trades with the other.
● The Arithmetic of Comparative Advantage♦ When countries differ in the relative efficiency
with which they produce different goods: ■Both world output and the welfare of each country
can be increased if: ● Each country specializes in producing the goods for
which it has a relative advantage;
● And then trades with the other.
TABLE 2: Alternative Outputs from One Year of Labor Input
TABLE 2: Alternative Outputs from One Year of Labor Input
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
Gains from Trade: An ExampleGains from Trade: An Example
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
Table 3
Example of the Gains from Trade
U.S. Japan Total
Computers + 25 − 10 +15
Televisions − 25 + 40 +15
● Suppose U.S. produce only Televisions
♦ Then there are 50 made
● And Japan only produces Computers
♦ So there is a total of 10
● Now they reallocate production:
♦ U.S. produce 25 TVs and 25 PCs
♦ Japan produces 40 TVs and 0 PCs
● What happens with total production?
● Suppose U.S. produce only Televisions
♦ Then there are 50 made
● And Japan only produces Computers
♦ So there is a total of 10
● Now they reallocate production:
♦ U.S. produce 25 TVs and 25 PCs
♦ Japan produces 40 TVs and 0 PCs
● What happens with total production?
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Calculating Opportunity Costs for U.S.Calculating Opportunity Costs for U.S.
● Suppose U.S. produce only TVs♦ If so, they produce 50
● Now they want 1 PC● How many televisions must give up
producing?♦ Exactly 1, so now produce 1 PC and 49 TVs
● Costs of making 1 PC is 1 TV that we don’t produce – that’s opportunity costs!
● Suppose U.S. produce only TVs♦ If so, they produce 50
● Now they want 1 PC● How many televisions must give up
producing?♦ Exactly 1, so now produce 1 PC and 49 TVs
● Costs of making 1 PC is 1 TV that we don’t produce – that’s opportunity costs!
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Calculating Opportunity Costs for JapanCalculating Opportunity Costs for Japan
● Suppose Japan produces only TVs♦ If so, they produce 40
● Now they want 1 PC
● How many TVs must give up producing?♦ 4, so now produce 36 TVs and 1 PC
● Costs of making 1 PC is 4 TV sets they do not produce – that’s opportunity costs!
● Suppose Japan produces only TVs♦ If so, they produce 40
● Now they want 1 PC
● How many TVs must give up producing?♦ 4, so now produce 36 TVs and 1 PC
● Costs of making 1 PC is 4 TV sets they do not produce – that’s opportunity costs!
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Opportunity Costs ComputedOpportunity Costs Computed
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Table 4
Opportunity Costs
U.S. Japan
Computers 1 unit of TVs 4 units of TVs
Televisions 1 unit of PCs ¼ units of PCs
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Exchange PriceExchange Price
● What (relative) price will prevail?♦ Need a more complicated model to answer♦ But can say something here!
● Let p be the relative price of PCs♦ If p < 1, U.S. won’t sell PCs♦ If p > 4, Japan won’t buy PCs
● So p is between 1 and 4● Assume p =2
● What (relative) price will prevail?♦ Need a more complicated model to answer♦ But can say something here!
● Let p be the relative price of PCs♦ If p < 1, U.S. won’t sell PCs♦ If p > 4, Japan won’t buy PCs
● So p is between 1 and 4● Assume p =2
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
The Law of Comparative AdvantageThe Law of Comparative Advantage
● The Graphics of Comparative Advantage♦ Production possibilities frontiers for two
countries can show: ■Different opportunity costs■The potential gains from trade
● The Graphics of Comparative Advantage♦ Production possibilities frontiers for two
countries can show: ■Different opportunity costs■The potential gains from trade
FIGURE 1: Per-Capita PPFs for Two Countries
FIGURE 1: Per-Capita PPFs for Two Countries
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
60
U.S. production possibilities frontier
S N
J
60
50
40
30
10
Japanese production possibilities frontier
10 0 20 30 40 50
20
Tel
evi
sio
n S
ets
(mil
lio
ns)
Computers (millions)
U
FIGURE 2: The Gains from TradeFIGURE 2: The Gains from Trade
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
U
U.S. production possibilities
100
90
80
70
60
50
40
30
20
10
A
60 50 40 20 10
U.S. consumption possibilities
S
30 0
Te
lev
isio
n S
ets
Computers
(b) United States
Japanese production possibilities
100
90
80
70
60
50
40
30
20
10
J
60 50 40 20 10
Japanese consumption possibilities
P N
30 0
Te
lev
isio
n S
ets
Computers
(a) Japan
D
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Tariffs, Quotas, and Other Interferences with TradeTariffs, Quotas, and Other Interferences with Trade
● Countries can reduce imports by setting tariffs or quotas.♦ Tariff – like a per-unit tax on the good traded
♦ Quota – limit on the quantity traded
● They can promote exports by subsidizing export goods.
● Countries can reduce imports by setting tariffs or quotas.♦ Tariff – like a per-unit tax on the good traded
♦ Quota – limit on the quantity traded
● They can promote exports by subsidizing export goods.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
●Reasons why countries may restrict trade:♦Gain a price advantage
♦Protect particular industries (infant industry argument)
♦National defense and other non-economic reasons
●Reasons why countries may restrict trade:♦Gain a price advantage
♦Protect particular industries (infant industry argument)
♦National defense and other non-economic reasons
Why Inhibit Trade?Why Inhibit Trade?
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TABLE 4: Estimated Costs of Protectionism to Consumers
TABLE 4: Estimated Costs of Protectionism to Consumers
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Trade is BeneficialTrade is Beneficial
● Under most circumstances, international trade enhances our standard of living.
● There are always winners and losers♦ But winners usually win more than losers lose
● So trade is beneficial
● Under most circumstances, international trade enhances our standard of living.
● There are always winners and losers♦ But winners usually win more than losers lose
● So trade is beneficial
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