1. Frank & Bernanke 3rd edition, 2007
Ch. 9: International Trade

2. Comparative Advantage
The principle of comparative advantage tells us that we can all enjoy more goods and services when each country produces according to its comparative advantage, and then trades with other countries.

3. Computers (number/year)
Production Possibilities Curve for a Many-Worker Economy B C A D
Observations
The OC of producing an additional unit = the slope of the line that touches the point
OC will increase as output of on good increases
100,000
40,000
1,000
2,000
Coffee (pounds/year)
Computers (number/year)

4. Production and Consumption Possibilities and the Benefits of Trade
In a closed economy:
Society’s production possibilities = consumption possibilities.
If a country is self-sufficient, it is called autarky.
In an open economy:
The society’s consumption possibilities are typically greater than its production possibilities.

5. Buying and Selling in World Markets
Computers/year
Coffee (pounds/year) B C A D
Assume:
Producing at D
Closed economy
World price of coffee = $10/lb and computer = $500
120,000
100,000
1,000
50,000
2,000
2,400
150,000
3,000

6. Buying and Selling in World Markets
Computers/year
Coffee (pounds/year) B C A D F
Observation:
Sell 2,000 $500
Take the $1million and buy 100,000 pounds of coffee
Consumption possibilities of 150,000 is greater than PPC without trade E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities

7. Buying and Selling in World Markets
Computers/year
Coffee (pounds/year) B C A D F
Observation:
Start at D
Sell 50,000 lbs of coffee
Buy 1,000 computers with the $500,000
Pt F is possible with trade but not on the PPC E
150,000
120,000
100,000
1,000
50,000
2,000
2,400
3,000
Consumption
possibilities
Production
possibilities

8. Optimal Production Mix for an Open Economy
160,000 L
Consumption
possibilities
150,000 E
50 lbs of coffee trades for 1 computer
LM = consumption possibilities
G is the optimal combination for Costa Rica
Costa Rica can use trade to locate anywhere along LM A
120,000
100,000 C G
Coffee (pounds/year)
50,000 D
Production
possibilities B F M
1,000
2,000
2,400
3,000
3,200
Computers/year

9. Optimal Production Mix for an Open Economy
160,000 L
Consumption
possibilities
150,000 E
Why produce at G?
Slope of the PPC = LM
Domestic and international opportunity costs of acquiring an extra computer (in terms of forgone coffee) are equal A
120,000
100,000 C G
Coffee (pounds/year)
50,000 D
Production
possibilities B F M
1,000
2,000
2,400
3,000
3,200
Computers/year

10. A Straight-Line PPC A B C D 800 600 Coffee (pounds/year) 200 200 600
Observation
The tradeoff between coffee and tea is constant at any point on the PPC
800 B
600
Coffee (pounds/year) C
200 D
200
600
800
Tea (pounds/year

11. Two Consumption Possibilities Curves
Tea (pounds/year
Coffee (pounds/year) B C A D’
600
200
800
1,600 D
Islandia produces at A
Islandia can use the money earned from selling 800 lbs of coffee to choose any combination on AD’
Consumption possibilities curve when the world price of coffee is twice the world price of tea

12. Two Consumption Possibilities Curves
Tea (pounds/year
Coffee (pounds/year) B C A
600
200
800
1,600 D
Islandia produces at D
Islandia can choose any combination on A’D
Consumption possibilities curve when the world price of tea is twice the world price of coffee A’

13. Consumption Possibilities With and Without International Trade
With a bow-shaped PPC consumption possibilities is typically maximized by producing where the PPC is tangent to the consumption possibilities line.
With a straight-line PPC production is completely specialized.

14. Does “cheap” foreign labor pose a danger to high-wage economies?
Scenario
U.S. and Fredonia produce software and beef.
Real wages in Fredonia are lower than in the U.S.
Fredonia is half as productive as the U.S. in beef production.
Fredonia is one-tenth as productive in software production.

15. Does “cheap” foreign labor pose a danger to high-wage economies?
Outcome
Fredonia has a comparative advantage in beef.
U.S. has a comparative advantage in software.
The U.S. will trade software for beef and increase its consumption of both.
Employment in the software industry in the U.S. increases and employment in the beef industry will decrease.

16. The Market for Computers in Costa Rica
2,000
4,800
2,400
1,400
400
Domestic
demand
supply
Consumer surplus
without trade = $1mil/yr
Producer surplus
1,000 E
Domestic
demand
supply
Consumer surplus
with trade = $1.96mil/yr
Producer surplus
with trade = $360K/yr
World
price
2,000
4,800 E F
1,200
2,800
Computer Imports
Computer per year
Without Trade
Computer per year
With Trade

17. A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is greater than the world price, and that economy opens itself to trade, the economy will tend to become a net importer of that good or service.

18. The Market for Coffee in Costa Rica
100,000
240,000 12 7 4
Domestic
demand
supply
Consumer surplus
without trade = $250K/yr
Producer surplus
without trade = $150K/yr E
100,000 12 7 4
Domestic
demand
Consumer surplus
with trade = $40K/yr
Producer surplus
with trade = $600K/yr E
supply
World
price F
40,000
200,000
240,000
Coffee exports 10
Coffee (pounds/year)
Without Trade
Coffee (pounds/year)
With Trade

19. A Supply and Demand Perspective on Trade
If the price of a good or service in a closed economy is lower than the world price, and that economy opens itself for trade, the economy will tend to become a net exporter of that good or service.

20. Mutually Beneficial Gains from Trade
Countries will profit by exporting the goods and services for which they have a comparative advantage.
The revenue from the exports are used to import goods and services for which they do not have a comparative advantage.
The markets will ensure that goods will be produced where opportunity cost is lowest.
The consumption possibilities will be maximized.

21. Price of computers ($/computer)
Exercise
Computers per year
Price of computers ($/computer)
200
Domestic
supply
World
price
demand
500
800
1,200
600
2,100
2,400
Question
Given the graph shown, what impact would trade have on producer and consumer surplus?

22. Winners and Losers from Trade
Consumers of imported goods
Producers of exported goods
Losers
Consumers of exported goods
Producers of imported goods

23. Protectionism Protectionism Tariff Quota Other
The view that free trade is injurious and should be restricted
Tariff
A tax imposed on an imported good
Quota
A legal limit on the quantity of a good that may be imported
Other
Red-tape barriers
Regulations

24. Import Tariff on Computers
1,000
1,200
Domestic
supply
World price
demand
4,800
400
2,400 E
2,800
Imports
without
tariff
Price of computers ($/computer)
1,200
World price + tariff
1,600
2,400
Computers per year

25. The Market for Computers after the Imposition of an Import Tariff
Consumer surplus
with tariff = 1.44K/yr
Domestic
supply
2,400
Tariff revenue =
$160K/yr E
Price of computers ($/computer)
World price + tariff
1,200
1,000
World price
Imports
with
tariff
400
Domestic
demand
Producer surplus
with tariff = 640K/yr
1,200
1,600
2,400
2,800
4,800
Computers per year

26. Price of computers ($/computer)
Exercise
Domestic
supply
3,600
Question
Given the graph shown, how will a tariff of $300 per computer affect total economic surplus?
2,100
Price of computers ($/computer)
1,500
World
price
1,200
600
Domestic
demand
200
300
500
700
800
1,200
Computers per year

27. Protectionist Policies
What do you think?
Why did President George W. Bush support the imposition of tariffs on steel imported into the United States?

28. Protectionist Policies
Quotas
Legal limit on the number or value of foreign goods that can be imported
Can be enforced by issuing permits

29. Imposition of an Import Quota
1,200
2,800
Imports with free trade = 1,600 computers/yr
1,000
Domestic supply
World price
Domestic
demand
4,800
2,400 E
1,400
2,000
400
1,200
1,600
2,400
Domestic supply + quota F
Price of computers ($/computer)
Computers per year

30. The Market for Computers after the Imposition of an Import Quota
Domestic supply
Consumer surplus
with quota = $1,440K/yr
2,400
1,200
1,600
2,400
Domestic supply + quota F E
Economic rent to holders of import licenses = $80K/year
1,400
Price of computers ($/computer)
1,000
World price
Imports = 800 computers/year
400
Domestic
demand
Producer surplus with quota = $640K/yr
1,200
2,800
4,800
2,000
Computers per year

31. Quotas & Tariffs Market effects are the same.
Tariffs generate tax revenue.
Quotas generate revenue for the firms that hold an import license.

32. Quotas
Who benefited from and who was hurt by voluntary export restraints on Japanese automobiles in the 1980s?

33. The Inefficiency of Protectionism
Trade barriers are inefficient and reduce the size of the economic pie.
Because trade barriers benefit certain groups, and these groups may be well organized, they may be successful in lobbying for trade barriers.
The gains from trade could be used to assist groups that have been hurt by trade.

34. Outsourcing
A term increasingly used to connote having services performed by low-wage workers overseas
Outsourcing of services to low-wage foreign workers is exactly analogous to the importation of goods manufactured by low-wage foreign workers.

35. Outsourcing
Characteristics of Jobs that are Less Susceptible to Outsourcing
Less rules-based jobs
“Face-to-Face” complex communication jobs
Jobs that require the worker to be physically present

36. Outsourcing
Responding to changing economic conditions requires the ability to adapt quickly to new circumstances.
Education provides the means to develop a comparative advantage that is not rules-based and does require complex face-to-face communication.