special supplementary slides on free trade trade theory n.
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Special supplementary slides on free trade & trade theory. Economists believe in free trade because free trade allows businesses and nations to find their comparative advantage If a country has comparative advantage in something, economists believe it should succeed without subsidies.

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slide2
Economists believe in free trade because free trade allows businesses and nations to find their comparative advantage
    • If a country has comparative advantage in something, economists believe it should succeed without subsidies
free trade means no barriers
“Free trade” means no barriers
  • The principle: You should have the same incentives when you consider a product from abroadas from your home country.
slide4

An industry in which a nation has comparative advantage is an industry in which that country produces relatively efficiently (compared to other industries in that country).

    • All nations have comparative advantage in something
slide5

Your country has comparative advantage in the product or service where the ratio Resources required in your country . Resources required in the other country

is low

free trade theory is based on some basic free market economics
Free trade theory is based on some basic free-market economics
  • Two fundamental principles
    • The price for which sellers are willing to sell a product indicates what all the resources to produce (and sell) it are worth.
    • The price for which buyers will buy indicates what the product is worth to the buyer
  • So economists think anything that manipulates prices is dangerous
slide7
Economists prefer income taxes or sales taxes (on everything) rather than tariffs (on particular imports)
    • For any given amount of revenue raised, income and sales taxes disrupt the market less than tariffs
most economists only make 1 or 2 exceptions
Most economists only make 1 or 2 exceptions
  • Exception 1: tariffs to protect infant industries
  • These are industries that lack comparative advantage, but could develop it soon
    • Example: Textile manufacturing in Vietnam in the 1980s
      • Because few Vietnamese were experienced in textile manufacturing, it was relatively less efficient than rice-growing
      • But as Vietnamese got experienced, they soon learned to produce textiles efficiently
slide9

Exception 2: strategic trade policy

    • Sometimes when a brand new industry is invented, people can recognize
      • It will have economies of scale (the people that produce most will produce cheapest)
      • There will be big learning effects (the people who produce first will produce cheapest)
    • So subsidies may be worthwhile
      • Example: flat-panel computer displays when they had just been invented
smith ricardo and their successors advocated free trade
Smith, Ricardo and their successors advocated free trade
  • They believed that if people were left to trade on their own, they would naturally trade the goods in which their countries had comparative advantage
    • “Every individual seeks the most advantageous employment for his capital….
    • “Study of his own advantage necessarily leads him to prefer that employment most advantageous to society” - Adam Smith, 1776
in the 19 th century free trade was widely practiced
In the 19th century, free trade was widely practiced
  • In Europe, tariffs were low or non-existent
  • But after WW I and especially in the early 30s, nations raised tariffs to protect their domestic economies
  • A disastrous depression followed
gatt was created to prevent the mistakes of the 30s from repeating
GATT was created to prevent the mistakes of the 30s from repeating
  • It provided a framework for negotiating reductions in tariffs and non-tariff barriers
  • The WTO continued the process and provided an enforcement mechanism to prevent new barriers
so tariffs are not free trade
So – tariffs are notfree trade
  • The WTO (and almost all economists) discourage use of tariffs
    • to raise funds
    • to protect an industry that already has comparative advantage
      • In the homework question, answers suggesting tariff protection for handmade blankets and wool would not get WTO support