International Trade

Review: Comparative Advantage Absolute Advantage: able to produce more per unit of labor Absolute Advantage: able to produce more per unit of labor Comparative Advantage: able to produce at a lower opportunity cost Comparative Advantage: able to produce at a lower opportunity cost Countries benefit through trade with countries that have a comparative advantage Countries benefit through trade with countries that have a comparative advantage In situations wherein countries face increasing opportunity costs, total specialization may be inefficient In situations wherein countries face increasing opportunity costs, total specialization may be inefficient

Extending Benefits: Exports Country can increase benefits through exporting when it has a comparative advantage Country can increase benefits through exporting when it has a comparative advantage Price rises in domestic market to reflect higher world price Price rises in domestic market to reflect higher world price Consumer surplus decreases as consumers pay higher price Consumer surplus decreases as consumers pay higher price Supplier surplus increases as suppliers earn higher price Supplier surplus increases as suppliers earn higher price Total surplus increases Total surplus increases

Extending Benefits: Imports Country can increase benefits through importing when it lacks a comparative advantage Country can increase benefits through importing when it lacks a comparative advantage Price falls in domestic market to reflect lower world price Price falls in domestic market to reflect lower world price Consumer surplus increases as consumers pay lower price Consumer surplus increases as consumers pay lower price Supplier surplus decreases as suppliers earn lower price Supplier surplus decreases as suppliers earn lower price Total surplus increases Total surplus increases

Terms of Trade Countries will trade products at a price somewhere between each country’s opportunity cost Countries will trade products at a price somewhere between each country’s opportunity cost Each country will benefit: increase total surplus Each country will benefit: increase total surplus If price is outside the range, trade won’t take place (better deal inside one’s own country) If price is outside the range, trade won’t take place (better deal inside one’s own country)

Trade Restrictions Despite advantages to trade, countries do erect barriers Despite advantages to trade, countries do erect barriers (How does “public choice” theory explain why?) (How does “public choice” theory explain why?) Quotas: limit amount of an import Quotas: limit amount of an import Tariffs: tax import as it enters country to raise price artificially Tariffs: tax import as it enters country to raise price artificially Who benefits? Who benefits? Who loses? Who loses? What happens to country’s total consumer and supplier surplus? What happens to country’s total consumer and supplier surplus?

Justifications for Barriers National security: “oil is too important to leave entirely to other countries” National security: “oil is too important to leave entirely to other countries” Job Protection Job Protection Foreign human rights Foreign human rights Environmental protection laws Environmental protection laws Remember that a clean environment is a “normal” good Remember that a clean environment is a “normal” good Americans would sink to working conditions of developing world Americans would sink to working conditions of developing world True? True? Why are American workers paid more? (think MRP) Why are American workers paid more? (think MRP) Remember: comparative advantage is the key, not comparative wage rates Remember: comparative advantage is the key, not comparative wage rates

Justifications for Barriers Protect infant industries (especially in developing countries) Protect infant industries (especially in developing countries) In past, IMF has counseled countries to open their markets In past, IMF has counseled countries to open their markets Currently, IMF is reconsidering that advice Currently, IMF is reconsidering that advice “Dumping” “Dumping” One country sells product below cost to produce, in order to force another country out of industry One country sells product below cost to produce, in order to force another country out of industry Tariff can counter dumping Tariff can counter dumping