17 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No.

17

International Trade and Comparative Advantage

No nation was ever ruined by trade.BENJAMIN FRANKLIN

● Why Trade?

● International versus Intranational Trade

● The Law of Comparative Advantage

● Supply, Demand, and Pricing in World Trade

● Tariffs, Quotas, and Other Interferences with Trade

● Why Trade?

● International versus Intranational Trade

● The Law of Comparative Advantage

● Supply, Demand, and Pricing in World Trade

● Tariffs, Quotas, and Other Interferences with Trade

ContentsContents

Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

● Why Inhibit Trade?

● Can Cheap Imports Hurt a Country?

● Why Inhibit Trade?

● Can Cheap Imports Hurt a Country?

Contents (continued)Contents (continued)


TABLE 1: Labor Costs in Industrialized Countries

TABLE 1: Labor Costs in Industrialized Countries


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.


● 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?


● International and intranational trade are similar in many respects.

● International and intranational trade are similar in many respects.

International versus Intranational TradeInternational versus Intranational Trade


● 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


The Law of Comparative AdvantageThe Law of Comparative Advantage

● One country is said to have 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 is said to have 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 is said to have a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country.

● One country is said to have a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country.




● 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.

● 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.

● Both countries gain from trade even if one of them is more efficient than the other in producing everything.



● 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


TABLE 3: Example of the Gains from Trade

TABLE 3: Example of the Gains from Trade




● 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


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


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


Comparative Advantage: “Cheap Foreign Labor”Comparative Advantage: “Cheap Foreign Labor”

● A country can benefit from trade, even if wages in the other country are considerably lower than its own wages.

● A country can benefit from trade, even if wages in the other country are considerably lower than its own wages.

??


Tariffs, Quotas, and Other Interferences with TradeTariffs, Quotas, and Other Interferences with Trade

● Countries can reduce imports by setting tariffs or quotas.

● They can promote exports by subsidizing export goods.

● Countries can reduce imports by setting tariffs or quotas.

● They can promote exports by subsidizing export goods.



● Tariff = tax on imports

● Quota = legal limit on the amount of a good that may be imported

● Export subsidy = government payment to an exporter

● Tariff = tax on imports

● Quota = legal limit on the amount of a good that may be imported

● Export subsidy = government payment to an exporter



● Tariffs versus Quotas♦ When imports are to be reduced, tariffs are

generally preferable to quotas because:■Tariffs generate income for the government■Unlike quotas, tariffs offer no special benefits to

inefficient exporters

● Tariffs versus Quotas♦ When imports are to be reduced, tariffs are

generally preferable to quotas because:■Tariffs generate income for the government■Unlike quotas, tariffs offer no special benefits to

inefficient exporters


● Reasons why countries may restrict trade:♦ Gain a price advantage

♦ Protect particular industries

♦ National defense and other non-economic reasons

♦ Infant-industry argument

♦ Strategic trade policy

● Reasons why countries may restrict trade:♦ Gain a price advantage

♦ Protect particular industries

♦ National defense and other non-economic reasons

♦ Infant-industry argument

♦ Strategic trade policy

Why Inhibit Trade?Why Inhibit Trade?


Why Inhibit Trade?Why Inhibit Trade?

● But retaliation may eliminate their advantage and make all countries worse off.

● But retaliation may eliminate their advantage and make all countries worse off.

TABLE 4: Estimated Costs of Protectionism to Consumers

TABLE 4: Estimated Costs of Protectionism to Consumers


How Popular Is Protectionism?How Popular Is Protectionism?


37%

56%

42%

Free traders

Protectionists

47%

Per

cen

tag

e

United States World


● Dumping = selling goods in a foreign market at lower prices than those charged in the home market

● Cheap imports: ♦ Benefit consumers

♦ Hurt some domestic businesses and their workers

● Dumping = selling goods in a foreign market at lower prices than those charged in the home market

● Cheap imports: ♦ Benefit consumers

♦ Hurt some domestic businesses and their workers

Can Cheap Imports Hurt a Country?Can Cheap Imports Hurt a Country?


Can Cheap Imports Hurt a Country?Can Cheap Imports Hurt a Country?

● Those who are hurt by cheap imports may fight to prevent their losses.

● Politics often leads to the adoption of protectionist measures that would be rejected on strictly economic terms.

● Those who are hurt by cheap imports may fight to prevent their losses.

● Politics often leads to the adoption of protectionist measures that would be rejected on strictly economic terms.


A Last Look at the “Cheap Foreign Labor” ArgumentA Last Look at the “Cheap Foreign Labor” Argument

● Labor is cheap in countries where productivity is low.

● Labor is expensive in countries like the United States where labor productivity is high.

● Labor is cheap in countries where productivity is low.

● Labor is expensive in countries like the United States where labor productivity is high.

??


A Last Look at the “Cheap Foreign Labor” ArgumentA Last Look at the “Cheap Foreign Labor” Argument

● Under most circumstances, international trade enhances our standard of living.

● Under most circumstances, international trade enhances our standard of living.

??

Appendix: Supply, Demand, and Pricing in

World Trade


Supply, Demand, and Pricing in World TradeSupply, Demand, and Pricing in World Trade

● In a two-country supply-demand model without trade restrictions:♦ The price of a good must be the same in both

countries

♦ The quantity of a good exported from one country must equal the quantity imported by the other

● In a two-country supply-demand model without trade restrictions:♦ The price of a good must be the same in both

countries

♦ The quantity of a good exported from one country must equal the quantity imported by the other


FIGURE 3: Supply-Demand in the International Wheat Trade

FIGURE 3: Supply-Demand in the International Wheat Trade

Pri

ce

of

Wh

ea

t p

er

Bu

sh

el

Importing country’s

supply

Importing country’s demand

Quantity of Wheat

(b) Importing Country

0

Imports

C D

H G

Pri

ce

of

Wh

ea

t p

er

Bu

sh

el

2.50

$3.25

Exporting country’s

supply

Exporting country’s demand

Quantity of Wheat

(a) Exporting Country

0

Exports

A B

F E


Supply, Demand, and Pricing in World TradeSupply, Demand, and Pricing in World Trade

● How Tariffs and Quotas Work♦ Both tariffs and quotas

price of imports quantity of imports

♦ Any restriction of imports that is accomplished by a quota normally can also be accomplished by a tariff

● How Tariffs and Quotas Work♦ Both tariffs and quotas

price of imports quantity of imports

♦ Any restriction of imports that is accomplished by a quota normally can also be accomplished by a tariff

FIGURE 4: Quotas and Tariffs in International Trade

FIGURE 4: Quotas and Tariffs in International Trade


95 87.5 57.5 50 125 115 85 80

2.50

$3.25

Importing country’s

supply

Importing country’s demand

Quantity of Wheat

(b) Importing Country

0

C D

T Q

Pri

ce

of

Wh

ea

t p

er

Bu

sh

el

Pri

ce

of

Wh

ea

t p

er

Bu

sh

el

2.00

$2.50

Exporting country’s

supply Exporting country’s demand

Quantity of Wheat

(a) Exporting Country

0

R

A

S

B

17 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No.

Documents

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intranational trade

foreign trade

trade contents copyright

world trade tariffs

country international

relative advantage

absolute advantage