2 2 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No.

2

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

● 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.


● 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?


● 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


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.


● 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



● 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.



● 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


Gains from Trade: An ExampleGains from Trade: An Example


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?


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!


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!


Opportunity Costs ComputedOpportunity Costs Computed


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


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



● 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

D


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.


●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?


TABLE 4: Estimated Costs of Protectionism to Consumers

TABLE 4: Estimated Costs of Protectionism to Consumers



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


The EndThe End

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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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