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

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Presentation on theme: "17 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No."— Presentation transcript:

1 17 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN

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

3 Why Inhibit Trade? Can Cheap Imports Hurt a Country? Why Inhibit Trade? Can Cheap Imports Hurt a Country? Contents (continued) Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

4 TABLE 1: Labor Costs in Industrialized Countries Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

5 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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.

6 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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?

7 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. International and intranational trade are similar in many respects. International versus Intranational Trade

8 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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 Trade

9 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. The 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.

10 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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

11 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. The 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.

12 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. The Law of Comparative Advantage Both countries gain from trade even if one of them is more efficient than the other in producing everything.

13 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. The 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.

14 TABLE 2: Alternative Outputs from One Year of Labor Input Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

15 TABLE 3: Example of the Gains from Trade Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

16 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. The 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

17 FIGURE 1: Per-Capita PPFs for Two Countries Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 60 U.S. production possibilities frontier SN J Japanese production possibilities frontier Television Sets (millions) Computers (millions) U

18 FIGURE 2: The Gains from Trade Copyright © 2006 South-Western/Thomson Learning. All rights reserved. U U.S. production possibilities A U.S. consumption possibilities S 300 Television Sets Computers (b) United States Japanese production possibilities J Japanese consumption possibilities PN 300 Television Sets Computers (a) Japan

19 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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. ?

20 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Tariffs, 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.

21 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Tariffs, Quotas, and Other Interferences with Trade 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

22 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Tariffs, Quotas, and Other Interferences with Trade 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

23 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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?

24 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Why Inhibit Trade? But retaliation may eliminate their advantage and make all countries worse off.

25 TABLE 4: Estimated Costs of Protectionism to Consumers Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

26 How Popular Is Protectionism? Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 37% 56% 42% Free traders Protectionists 47% Percentage United StatesWorld

27 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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?

28 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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.

29 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. A 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. ?

30 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. A Last Look at the Cheap Foreign Labor Argument Under most circumstances, international trade enhances our standard of living. ?

31 Appendix: Supply, Demand, and Pricing in World Trade

32 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Supply, 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

33 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. FIGURE 3: Supply-Demand in the International Wheat Trade Price of Wheat per Bushel Importing countrys supply Importing countrys demand Quantity of Wheat (b) Importing Country 0 Imports C D HG Price of Wheat per Bushel 2.50 $3.25 Exporting countrys supply Exporting countrys demand Quantity of Wheat (a) Exporting Country 0 Exports AB FE

34 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Supply, 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

35 FIGURE 4: Quotas and Tariffs in International Trade Copyright © 2006 South-Western/Thomson Learning. All rights reserved $3.25 Importing countrys supply Importing countrys demand Quantity of Wheat (b) Importing Country 0 CD TQ Price of Wheat per Bushel 2.00 $2.50 Exporting countrys supply Exporting countrys demand Quantity of Wheat (a) Exporting Country 0 R A S B


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