Chapter 34

1. Chapter 34 International Trade and Comparative Advantage No nation was ever ruined by trade. BENJAMIN FRANKLIN

2. Table 1 Labor costs in industrialized countries as a percentage of U.S. labor costs

3. Why Trade? • Countries – differences: • Resources • Distributed unequally across planet • Natural endowments • Climate, terrain • Skills of labor force • Specialization in production

4. Why Trade? • Specialization, country • Devotes energies & resources • Small proportion of world’s productive activities • Trade • To exploit advantages of specialization • Voluntary exchange • Everybody gains

5. 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. International vs. Intranational Trade • Intranational trade • Gain from specialization and free trade • 50 states of U.S. • Single national government • Same currency ($) • Labor & capital mobility

7. International vs. Intranational Trade • International trade • Gain from specialization and free trade • Political factors • Different governments • Many currencies • Impediments to labor & capital mobility • Immigration quotas • Restricted employment to foreigners • Foreign investment - risk

8. 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. 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. 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. Table 2 Alternative outputs from one year of labor input

12. Table 3 Example of the gains from trade

13. The Law of Comparative Advantage • Specialization & exchange • Change in production arrangements • World productivity – increase • Every country does • What it can do best • All countries – benefit • Increase production • Every commodity • No increase in • Amounts of resources used

14. Figure 1 Production possibilities frontiers for two countries (per million years of labor) 60 50 U.S. production possibilities frontier Japanese production possibilities frontier 40 Television sets (millions) 30 U S N J 20 10 0 10 20 30 40 50 60 Computers (millions)

15. The Law of 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 • Very different countries • Large gains from trade

16. The Law of Comparative Advantage • Two countries • Voluntarily trade two goods • With one another • Rate of exchange • Between goods • Must fall - in between price ratios • Prevail - in the absence of trade • Incomplete specialization • Some countries – too small • Production possibilities frontiers - curved

17. Figure 2 The gains from trade Japanese production possibilities Japanese consumption possibilities U.S. production possibilities 60 60 U.S. consumption possibilities 50 50 40 40 30 30 Television sets Television sets A U S N P J 20 20 10 10 0 0 10 10 20 20 30 30 40 40 50 60 Computers Computers (a) Japan (b) United states

18. Tariffs, Quotas, & other Interferences • Mercantilism - doctrine • Exports – good for a country • Imports – harmful • 1930s – protectionist, U.S. • Past 60 years, U.S. – decrease • Tariffs • Trade barriers

19. Tariffs, Quotas, & other Interferences • Control trade • Tariffs • Tax on imports • Quotas • Legal limit on imports • Export subsidies • Government payment to exporter • Reduce price • Compete in foreign markets

20. Tariffs, Quotas, & other Interferences • Tariffs vs. Quotas • Both • Reduce international trade • Increase price • Domestically produced goods • Tariffs • Profits from higher price • Foreign & domestic sellers • Quotas • Some of the profits • Revenue to government of importing country

21. Tariffs, Quotas, & other Interferences • Tariffs vs. Quotas • Tariffs • Promote efficiency • Quotas • May be • Political favoritism • Corruption • Preference for tariffs over quotas

22. Why Inhibit Trade? • 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

23. Why Inhibit Trade? • Protecting particular industries • Limit foreign competition • Preserve employment - protected industry • High cost • Consumers • Economy

24. Table 4 Estimated costs of protectionism to consumers

25. Why Inhibit Trade? • Free-trade & Government assistance • Temporary protection from sudden changes • Trade adjustment assistance • Special unemployment benefits • Loans • Retraining programs • Other aid • To workers & firms - harmed by foreign competition

26. Why Inhibit Trade? • National defense • Produce own national defense equipment • Other noneconomic considerations • Political • Infant-industry argument • Stands up only if • Glowing profit prospects • Private funds – unavailable

27. Can Cheap Imports Hurt a Country? • Dumping • Selling goods in a foreign market • At lower prices • Than those charged in home market

28. Supply, Demand, and Pricing in World Trade • Free trade, equilibrium price • Balance world supply and demand • Quantity exported by one country • Must = quantity imported by the other country • Price – same in both countries

29. Figure 3 Supply-demand equilibrium: international wheat trade Importing country’s supply Exporting country’s supply Exporting country’s demand 2.50 Price of wheat per bushel Price of wheat per bushel $3.25 G B A H E D F C Imports Exports Importing country’s demand Quantity of Wheat Quantity of Wheat (b) Importing country (a) Exporting country

30. How tariffs and quotas work • Tariffs • Raise prices • Reduce quantity of imports demanded • Quotas • Reduce supply • Raise prices

31. How tariffs and quotas work • Quotas - Reduce volume of trade • Raise price – importing country • Reduce price – exporting country • Tariffs • Quantity exported by one country • Must = quantity imported by the other country • Price paid (consumers, importing country) • = Tariff + price received (suppliers, exporting country)

32. Figure 4 Quotas and tariffs in international trade Importing country’s supply Price of wheat per bushel Price of wheat per bushel Exporting country’s demand Exporting country’s supply $2.50 2.50 $3.25 2.00 B A D Q R S T C Importing country’s demand 80 50 85 87.5 57.5 115 125 95 Quantity of Wheat Quantity of Wheat (b) Importing country (a) Exporting country