Chapter 16 Trading with Other Nations

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-2 Learning Objectives Make the distinction between imports and exports and know about the growth in world trade. State why comparative advantage is more important than absolute advantage. Explain the relationship between imports and exports. List and describe at least three arguments against free trade, and the two major ways of restricting imports.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-3 The Importance of World Trade Without any trading with other nations, it would be more costly to buy coffee, chocolate, or pepper in the United States. Most of the consumer electronics you purchase are made in other countries. Many of the raw materials used in manufacturing in this country are also purchased abroad.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-4 Imports Imports are those goods and services that we purchase from outside the United States. Imports include goods we consume directly, as well as many of the parts that go into the manufacturing of American-produced goods.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-5 Imports (cont.) Today, about 14 percent of the value of all final goods and services produced in the United States (GDP) is made up of imports. This is quite small in comparison to other countries. In Table 16-1,next, you see the relative importance of imports in selected countries.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-6 Table 16-1: The Importance of Imports in Selected Countries

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-7 Exports Exports are all of the goods and services that we sell to foreign countries. Each year we export over $700 billion of goods. In addition, we export about $300 billion of services. These include computer software, travel and tourism.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-8 World Trade—It Just Keeps Growing Back in the 1950s, imports and exports were only about 4 percent of the U.S. annual national income. Today, imports are over 14 percent, and exports about 12 percent of GDP. International trade has become more important for the United States. This is also true for the world.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved.16-9 Why Do Nations Trade? International trade occurs because the people of each nation have the ability to produce goods and services that residents of other nations find attractive in terms of price, quality, and special features.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Absolute Advantage The particular distribution of resources of a nation often gives it an absolute advantage over another nation in the production of one or more goods. Absolute advantage is defined as the ability to produce more output from given inputs than other producers can.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Comparative Advantage For an individual, comparative advantage is the ability to perform an activity at a lower opportunity cost than others. For a nation, comparative advantage is the ability of the nation to produce something at a lower opportunity cost that the producers of other nations.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Comparing Costs of Production Consider a hypothetical example in which we compare the cost of production of digital cameras and video game software. There are two countries in our example, the United States and Japan.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Table 16-2: The Comparative Costs of Production

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Specialization Specialization involves working in a relatively well-defined, limited endeavor. For the individual, specialization means engaging in one particular occupation. For a nation, specialization means producing a limited number of goods and services, rather than all goods and services that the nation’s residents consume.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Specialization in Our Example Let’s say that there are 1,000 worker in each country, each worker capable of producing either digital cameras or video games according to the numbers shown back in Table Table 16-3, next, shows daily world output before specialization with 1000 workers in each country, assuming that each country’s workers are divided equally between the production of the two goods.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Table 16-3: Daily World Output Before Specialization

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The Magic of Specialization and Trade—Increased World Output In Table 16-3, world output with 1,000 workers in each country is 1,000 digital cameras and 750 video games. Now assume that Japan only produces digital cameras, leaving to the U.S. the production of video games.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The Magic of Specialization and Trade—Increased World Output (cont.) Looking at Table 16-4, next, we see that the world output of digital cameras stays the same at 1,000. But the world output of video games is now 1,000, instead of 750. There has been a gain to world production of 250 video games. These are essentially “free” because of a more efficient allocation of resources worldwide.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Table 16-4: Daily World Output After Specialization

Copyright © 2005 Pearson Addison-Wesley. All rights reserved International Trade World output is greater when countries specializes in producing the goods in which they have a comparative advantage and then engage in foreign trade. But not everyone is better off when free trade occurs. In our example, U.S. digital camera producers and Japanese video game producers are worse off because these two domestic industries will have disappeared after complete specialization.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved International Trade (cont.) International trade can be viewed as a choice in each country between two ways of acquiring a good or service— produce it domestically or import the product. If the imported good is cheaper than the domestically produced equivalent good, a nation can gain by importing it.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved International Trade Leads to the Transmission of Ideas Among Nations International trade also bestows benefits on countries through the international transmission of ideas. According to economic historians, international trade has been the principal means by which new goods, services, and processes have spread around the world.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The Relationship Between Imports and Exports International trade can be looked at as a kind of production process that transforms exports into imports. What we gain as a country from international trade is the ability to import the things we want. In the long run, imports are paid for by exports.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The Impact of Restrictions on Imports Any restriction on imports ultimately reduces exports. If we restrict the ability of the rest of the world to sell its goods and services to us, then the rest of the world does not have the ability to purchase as many goods and services as we want to export.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Arguments Against Free Trade Protecting American jobs. Protecting infant industries—those that are just getting started. Government subsidization of foreign producers. Dumping—selling abroad at a lower price than at home, or selling at a price that is below the marginal cost of production.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Ways to Restrict Foreign Trade Quotas—an import quota is a restriction imposed on the value of or the number of units of a particular good that can be brought into the United States.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Ways to Restrict Foreign Trade (cont.) Tariffs—are taxes on imports. They can be set as a particular dollar amount per unit, say 10 cents per pound, or they can be set as a percentage of the value of the imported commodity.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved The World Trade Organization (WTO) Since 1995, the principle institution that oversees tariffs throughout the world has been the World Trade Organization (WTO). The goal of the nations that created the WTO was to lessen trade barriers throughout the world so that all nations can benefit from freer international trade.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Free Trade Areas and Common Markets The oldest and best-known common market is what is known to the world today as the European Union (EU). In 1993 the U.S. Congress approved NAFTA, an agreement that created a free trade zone that includes Canada, the United States, and Mexico.

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Key Terms and Concepts absolute advantage comparative advantage dumping exports import quota imports specialization tariffs