© 2001 South-Western, a division of Thomson Learning Economics: Principles and Applications, 2e by Robert E. Hall & Marc Lieberman © 2001 South-Western, a division of Thomson Learning

Chapter 16: Comparative Advantage and the Gains from Trade © 2001 South-Western, a division of Thomson Learning

The Logic of Free Trade Exports Goods and services produced domestically, but sold abroad. © 2001 South-Western, a division of Thomson Learning

The Logic of Free Trade Imports Goods and services produced abroad, but consumed domestically. © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage Opportunity Cost and Comparative Advantage Specialization and World Production Gains from International Trade The Terms of Trade © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage Absolute Advantage The ability to produce a good using fewer resources than another country. © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage The ability to produce a good at a lower opportunity cost than another country. © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage If countries specialize according to comparative advantage, a more efficient use of given resources occurs. © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage As long as opportunity costs differ, specialization and trade can be beneficial to all involved. This is true even if one party has an all-round absolute advantage or disadvantage. © 2001 South-Western, a division of Thomson Learning

The Theory of Comparative Advantage Terms of Trade The ratio at which a country can trade domestically produced products for foreign-produced products. © 2001 South-Western, a division of Thomson Learning

Turning Potential Gains into Actual Gains Exchange Rate The amount of one currency that is traded for one unit of another currency. © 2001 South-Western, a division of Thomson Learning

Turning Potential Gains into Actual Gains Some Important Provisos Costs of Trading Size of Countries Increasing Opportunity Cost Government Barriers to Trade © 2001 South-Western, a division of Thomson Learning

The Sources of Comparative Advantage Countries often specialize in products based on their own particular endowments of natural resources. But natural resources are not the only basis for comparative advantage. © 2001 South-Western, a division of Thomson Learning

The Sources of Comparative Advantage Countries often develop strong comparative advantages in the goods they have produced in the past, regardless of why they began producing those goods in the first place. © 2001 South-Western, a division of Thomson Learning

Why Some People Object to Free Trade The Impact of Trade in the Exporting Country The Impact of Trade in the Importing Country Attitudes Toward Free Trade: A Summary © 2001 South-Western, a division of Thomson Learning

Why Some People Object to Free Trade When the opening of trade results in increased exports of a good, the producers of the good are made better off and will support increased trade. Consumers of the good will be made worse off and will oppose increased trade. © 2001 South-Western, a division of Thomson Learning

Why Some People Object to Free Trade When the opening of trade results in increased imports of a product, the domestic producers of the product are made worse off and will oppose the increased trade. Consumers are better off and will favor the increased trade. © 2001 South-Western, a division of Thomson Learning

How Free Trade Is Restricted Tariffs Quotas © 2001 South-Western, a division of Thomson Learning

How Free Trade Is Restricted Tariff A tax on imports. © 2001 South-Western, a division of Thomson Learning

How Free Trade Is Restricted Tariffs reduce the volume of trade and raise the domestic prices of imported goods. In the country that imposes the tariff, producers gain and consumers lose. But the world as a whole loses because tariffs decrease the volume of trade and therefore decrease the gains from trade. © 2001 South-Western, a division of Thomson Learning

How Free Trade Is Restricted Quota A limit on the physical volume of imports. © 2001 South-Western, a division of Thomson Learning

How Free Trade Is Restricted Quotas have effects similar to tariffs--they reduce the quantity of imports and raise domestic prices. While both measures help domestic producers, they reduce the benefits of trade to the nation as a whole. © 2001 South-Western, a division of Thomson Learning

Protectionism Myths About Free Trade Sophisticated Arguments for Protection © 2001 South-Western, a division of Thomson Learning

© 2001 South-Western, a division of Thomson Learning Protectionism Protectionism The belief that a nation’s industries should be protected from foreign competition. © 2001 South-Western, a division of Thomson Learning

© 2001 South-Western, a division of Thomson Learning Protectionism “A high-wage country cannot afford free trade with a low-wage country.” “A low-productivity country cannot afford free trade with a high-productivity country.” “In recent times, America’s unskilled workers have suffered because of ever-expanding international trade.” © 2001 South-Western, a division of Thomson Learning

© 2001 South-Western, a division of Thomson Learning Protectionism According to strategic trade policy, a nation can gain in some circumstances by assisting certain “strategic” industries that benefit society as a whole, but that may not thrive in an environment of free trade. © 2001 South-Western, a division of Thomson Learning

© 2001 South-Western, a division of Thomson Learning Protectionism Production is most likely to reflect the principle of comparative advantage when firms can obtain funds for investment projects and when they can freely enter industries that are profitable. Thus, free trade, without government intervention, works best when markets are working well. © 2001 South-Western, a division of Thomson Learning