PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University 1 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN

Table 1 Labor Costs in Industrialized Countries as a Percentage of U.S. Labor Costs 2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Trade? Countries – differences: –Resources Distributed unequally across planet –Natural endowments Climate, terrain –Skills of labor force –Specialization in production 3 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Trade? Specialization –A country devotes its energies and resources –To only a small proportion of the world’s productive activities Trade –To exploit advantages of specialization 4 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Trade? International trade - greatly enhances living standards for all parties involved: –Every country lacks some vital resources That it can get only by trading with others –Each country’s climate, labor force, and other endowments Relatively efficient producer of some goods Relatively inefficient producer of others –Specialization permits larger outputs Via the advantages of large-scale production 5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Trade is a win-win situation Voluntary exchange / trade –Redistribute products –Both parties – gain Hold more preferred combinations of goods –Than they held before –Applies to Nations Individuals 6 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

International vs. Intranational Trade Intranational trade –Gain from specialization and free trade –50 states of U.S. –Single national government –Same currency ($) –Labor and capital mobility 7 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

International vs. Intranational Trade International trade –Gain from specialization and free trade –Political factors Different governments –Many currencies –Impediments to labor and capital mobility Immigration quotas Restricted employment to foreigners Foreign investment - risk 8 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Law of Comparative Advantage Absolute advantage –One country – over another –Produce a good –Use smaller quantities of resources Comparative advantage –One country - over another –Production of particular good Relative to other goods –Less inefficiently 9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Principle of comparative advantage David Ricardo (1772–1823) –Classical economist –Countries - gain from trade Even if one is more efficient –Than the other –In every industry One - absolute advantage –Producing every commodity 10 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Principle of comparative advantage Country - absolute disadvantage –Relative to another country Production of every good –Has a comparative advantage Good - least inefficient Most efficient patterns of production –Comparative advantage – matters –Absolute advantage – doesn’t matter 11 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Comparative Advantage Specialization and exchange –Change in production arrangements –World productivity – increase –Every country does what it can do best –All countries – benefit –Increase production in every commodity –No increase in amounts of resources used 12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Table 2 Alternative Outputs from One Year of Labor Input 13 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Table 3 Example of the Gains from Trade 14 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Figure 1 Production Possibilities Frontiers for Two Countries (person-years of labor) Television sets (millions) Computers (millions) 60 U S N J U.S. production possibilities frontier Japanese production possibilities frontier © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Comparative Advantage Country - absolute advantage –Higher per-capita production possibilities frontier Difference in comparative advantage –Difference in slopes of production possibilities frontiers Very similar countries –May gain little from trade 16 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Comparative Advantage Very different countries –Large gains from trade Two countries –Voluntarily trade two goods With one another –Rate of exchange between goods Must fall in between the price ratios that would prevail in the absence of trade 17 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Figure 2 The Gains from Trade Television sets Computers N Japanese production possibilities Television sets Computers 60 U U.S. production possibilities P Japanese consumption possibilities J (a) Japan(b) United states S A U.S. consumption possibilities © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Comparative Advantage Specialization may be incomplete –Some countries Are too small to provide the world’s entire output –Production possibilities frontiers are curved 19 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Interferences with Trade Tariffs, quotas, and other interferences with trade Mercantilism - doctrine –Exports are good for a country –Imports are harmful 1930s – protectionist, U.S. Past 60 years, U.S. – decrease –Tariffs –Trade barriers 20 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Interferences with Trade Control trade –Tariffs - Tax on imports –Quotas - Legal limit on imports –Export subsidies Government payment to exporter –Lower prices –Compete in foreign markets 21 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Interferences with Trade Tariffs vs. Quotas –Both reduce international trade –Both increase the price on domestically produced goods –Quotas: Profits from higher price Foreign and domestic sellers –Tariffs: Some of the profits Revenue to government of importing country 22 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Interferences with Trade Tariffs vs. Quotas –Tariffs Greater benefits to more efficient exporters Promote efficiency –Quotas May be political favoritism or corruption Preference for tariffs over quotas 23 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? 1.Gaining a price advantage –For domestic firms –Tariffs/quotas – benefit Particular domestic industries Country - able to impose them –Without fear of retaliation –When every country uses tariffs/quotas Every country - likely to lose in long run 24 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? 2.Protecting particular industries –Limit foreign competition –Preserve employment - protected industry High cost for consumers and the economy –Protective tariffs and quotas Designed to rescue firms that are too inefficient to compete with foreign exporters Consumers – cannot benefit from international specialization: better products at lower prices 25 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Table 4 Estimated Costs of Protectionism to Consumers 26 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? Free-trade and Government assistance –Temporary protection from sudden changes –Trade adjustment assistance Special unemployment benefits Loans Retraining programs Other aid To workers and firms harmed by foreign competition 27 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? 3.National defense –Produce own national defense equipment Even industries with the most peripheral relationship to defense are likely to invoke this argument on their behalf Other noneconomic considerations –Political grounds –Endangered species 28 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? 4.Infant-industry argument –New industries need to be protected from foreign competition Until they develop and flourish –Stands up only if the prospective future gains Are sufficient to repay the up-front costs of protectionism 29 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why Inhibit Trade? 5.Strategic argument for protection –A nation may sometimes have to threaten protectionism –To induce other countries to drop their own protectionist measures 30 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Can Cheap Imports Hurt a Country? Dumping –Selling goods in a foreign market –At lower prices than those charged in the home market Nation of consumers –We should be indignant when foreigners charge us high prices, not low ones 31 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Appendix Supply, Demand, and Pricing in World Trade Free trade, equilibrium price –Balance world supply and demand The quantity exported by one country Must equal the quantity imported by the other country –Price – the same in both countries 32 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Figure 3 Supply-Demand Equilibrium in the International Wheat Trade 33 (a) Exporting country Exporting country’s demand Exporting country’s supply Quantity of Wheat Price of wheat per bushel $ F (b) Importing country Importing country’s demand Importing country’s supply Quantity of Wheat Price of wheat per bushel C D H G A B E Exports Imports © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Appendix How tariffs and quotas work An import quota on a product –Reduces the volume of that product traded –Raises the price in the importing country –Reduces the price in the exporting country 34 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Appendix How tariffs and quotas work Tariffs –Quantity exported by one country Must equal the quantity imported by the other country –Price paid (consumers, importing country) = Tariff + price received (suppliers, exporting country) 35 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Figure 4 Quotas and Tariffs in International Trade 36 (a) Exporting country Exporting country’s demand Exporting country’s supply Quantity of Wheat Price of wheat per bushel 2.00 $2.50 (b) Importing country Importing country’s demand Importing country’s supply Quantity of Wheat Price of wheat per bushel B A R S 2.50 $ C D Q T © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.