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Chapter 33 International Trade

Comparative Advantage A country has a comparative advantage in producing a good if it can produce it at a lower opportunity cost than another country. Your country might have a lower opportunity cost because: it is more talented at making the good, or the good uses resources which are relatively abundant in your country.

Comparative Advantage and Trade Countries will export goods in which they have a comp. adv. Countries will import goods in which they do not have a comp. adv. This is efficient because every country gets to have the good for the lowest available opportunity cost.

Example: India and the US Compare ability to make cars and clothing. The opportunity cost of making a car is the clothing foregone (& vice versa). Suppose India uses 50% more resources to make cars but only 20% more resources to make clothing, compared to the US. The opportunity cost of producing clothing is lower in India, because you give up fewer cars there than you would in the US.

What if your country has no comparative advantage? Unlikely--remember comparative advantage is defined by opportunity cost, not absolute cost. It is defined by the value of foregone production, not by the amounts resources used. But, if you have no comparative advantage, then you are neither helped not hurt by trade.

Productivity and Comparative Advantage Consider Japan and the US. What if Japanese workers are more productive than the US? Japanese workers will be able to consume more than US workers, with or without trade.

Productivity and Comparative Advantage, Cont’d. Even though Japan can produce everything with fewer resources, the US will still be able to make something relatively cheaper. The US can still increase its consumption through trade with Japan-- it can import some goods more cheaply than it can make them at home.

Bottom Line Productivity & resources determine a country’s wealth. Trade increases that wealth.

Income Redistribution While trade can increase total consumption, not everyone benefits.

Trade helps factors used to produce exports. Increased demand for these factors pushes up their incomes.

Trade hurts factors used to produce imports. Decreased demand for these factors pushes down their incomes.

Net Gains by winners are larger than losses by losers. (More consumption in total.) Economists’ support of free trade is based on this net gain.

Artificial Barriers to Trade Import tariff--a tax on imports. Import quota--a legal max. amount that may be imported. Regulations--Product standards or health & safety regulations may make trade impractical.

Import Tariffs Like a sales tax, an import tariff forces up the price of a good. Consumers buy less. Domestic producers produce more. Imports fall.

Effects of Tariff Consumers are hurt. Producers (owners of the factors used to produce the good) are helped. Trade is reduced. Net: The losses outweigh the gains, because trade is reduced.

Political Economy Why is there trade protection? Consumers are many, each lose a little. Producers are few, each gain a lot. Producers tend to organize to lobby for trade protection.

Arguments for Protection

National Defense Argument (A): “Must have a functioning “_____” industry in case of war.” Counterargument (CA): Many of the industries that use this argument are not really crucial for war.

Infant Industry Argument A: “Our industry could be competitive if given a chance to mature.” CA: The industry may not become competitive because it is protected. CA: Politically difficult to remove protection once it is started.

Unfair Competition A: “Foreign producers use really cheap labor. It’s unfair to expect us to compete.” CA: Why not take advantage of cheap foreign labor? Use American labor only on goods in which it has a comparative advantage.

Dumping A: “Foreign producers sell their products in America for less than they sell them at home.” CA: That’s good for US consumers. Only a problem if US firms driven out of business and replaced by a foreign monopolist (unlikely).

Bottom Line There is seldom an economic justification for barriers to trade. Industries use these arguments to further their own interests at the expense of consumers.

Bottom Line The economy will use its resources most efficiently if it lets comparative advantage determine where they are used. Industries will rise or decline over time as comparative advantage changes.

Coming Up: Review for final exam Bring along your old copies of study guides Final Exam: Tuesday, May 7; 9:00-11:00; note later start time. Bring pencil, calculator, knowledge of economics,.