Chapter 33

1. Chapter 33 Comparative Advantage and the Open Economy

2. When representatives from around the world meet to discuss trade policies, it is clear that those who desire open borders often must change their own domestic policies in order to encourage other nations to let go of trade restrictions. Introduction

3. Learning Objectives • Discuss the worldwide importance of international trade • Explain why nations can gain from specializing in production and engaging in international trade • Distinguish between comparative advantage and absolute advantage

4. Learning Objectives • Understand common arguments against free trade • Describe ways that nations restrict foreign trade • Identify key international agreements and organizations that adjudicate trade disputes among nations

5. Chapter Outline • The Worldwide Importance of International Trade • Why We Trade: Comparative Advantage and Mutual Gains from Exchange • The Relationship Between Imports and Exports

6. Chapter Outline • International Competitiveness • Arguments Against Free Trade • Ways to Restrict Foreign Trade

7. Did You Know That... • Toys and many household items sold in the U.S. are increasingly manufactured overseas? • As each country specializes in producing certain goods, all countries can benefit?

8. The Worldwide Importance of International Trade • World GDP is nearly eight times greater than it was at the end of World War II. • World trade has increased to more than 24 times what it was in 1950.

9. The Worldwide Importance of International Trade • Since 1950, international trade has become more important to the economy of the United States. • Wheras imports added up to barely 4 percent of annual national income in 1950, today they account for over 14 percent.

10. The Growth of World Trade Source: Steven Husted and Michael Melvin, International Economics, 3rd ed. (New York: HarperCollins, 1995), p. 11, used with permission; World Trade Organization; Federal Reserve System; U.S. Department of Commerce. Figure 33-1, Panel (a)

11. The Growth of World Trade Source: Steven Husted and Michael Melvin, International Economics, 3rd ed. (New York: HarperCollins, 1995), p. 11, used with permission; World Trade Organization; Federal Reserve System; U.S. Department of Commerce. Figure 33-1, Panel (b)

12. World Trade Flows Figure 33-2

13. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Scenario (8-hour day) • Ad specialist • 2 pages of ad copy/hour • 1 art rendering/hour • Computer artist • 1 page of ad copy/hour • 1 art rendering/hour

14. 4 hrs x 2 = 8 4 hrs x 1 = 4 12 8 4 hrs x 1 = 4 4 hrs x 1 = 4 Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange Without Trade (8-hour day) Ad Specialist Computer Artist Total Copy Renderings

15. 16 8 Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange With Trade (8-hour day) Ad Specialist Computer Artist Total 8 hrs x 2 = 16 Copy Renderings 8 hrs x 1 = 8 Ad copy output increases by 4 pages per day

16. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Comparative Advantage • The ability to produce a good or service at a lower opportunity cost compared with producers

17. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Absolute Advantage • The ability to produce more output from given inputs or resources than other producers can

18. International Example: Power Moves Across Borders in South America • Most nations of South America generate their electric power by burning natural gas. • The cost of extracting and using natural gas is lower in Brazil than it is in neighboring Argentina or Uruguay. • Consequently, these countries import electric power from Brazil.

19. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Specialization among nations • Scenario • Two countries—India & United States • Two commodities—software programs and computers • One factor of production—labor • Workforce in each country—200

20. Comparative Costs of Production Product United States (worker-days) India (worker-days) Software programs 1 1 Computers 1 2

21. Comparative Costs of Production Daily World Output Without Specialization or Trade India United States Product Workers Output Workers Output World Output Software programs 100 100 100 100 200 Computers 100 100 100 50 150

22. Comparative Costs of Production Daily World Output With Specialization and Trade India United States Product Workers Output Workers Output World Output Software programs —— —— 200 200 200 Computers 200 200 ——— ——— 200 Computer output increases by 50 per day

23. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Observations on specialization and trade • Increase output without using more resources • Importing is a way of producing a good at a lower cost

24. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Observations on specialization and trade • Not everyone gains from trade • Cannot “run out of exports” • Every country will always have a comparative advantage in something

25. International Example: Mauritius Searches for a Comparative Advantage • Mauritius, an island nation in the Indian Ocean, once had a comparative advantage in the production of sugarcane. • From the 1970’s to the 1990’s, much of the labor force of the island was employed in textile production. • Now that textile work has largely relocated to China and India, Mauritius is again looking for an industry in which its workers can offer a comparative advantage.

26. Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange • Other benefits from international trade: the transmission of ideas • The transmission of new goods and services • Intellectual property • New processes or techniques of production

27. The RelationshipBetween Exports and Imports • In the long run, imports are paid for by exports. • Any restrictions on imports ultimately reduce exports. • When a country engages in trade, it is not competing against the other countries. • All nations stand to benefit from trade.

28. International Competitiveness • Is the U.S. competitive? • Ranks #1 in the world in overall productive efficiency • According to the Institute for Management Development in Lausanne, Switzerland

29. International Competitiveness • Reasons for ranking • Rapid economic growth since 1990–91 • Widespread entrepreneurship • Economic restructuring • Sophisticated financial system • Large investments in scientific research

30. Example: U.S. Service Exports Gain on Merchandise Exports • As a fraction of total U.S. exports, services are becoming more predominant. • This shows that the opportunity cost of producing services is relatively low in the U.S. compared to other nations.

31. Arguments Against Free Trade • Infant Industry Argument • The contention that tariffs should be imposed to protect from import competition an industry that is trying to get started • Presumably, after the industry becomes technologically efficient, the tariff can be lifted.

32. Arguments Against Free Trade • Countering foreign subsidies • Countering Dumping • Selling a good or a service abroad at a price below its cost of production or below the price charged in the home market

33. Arguments Against Free Trade • Protecting domestic jobs • Do imports reduce jobs? • No empirical evidence • In half of the cases studied, when imports rose, unemployment fell

34. Arguments Against Free Trade • The cost of protecting U.S. jobs • Restrictions on textiles and apparel goods cost U.S. consumers $9 billion/year • Cost $50,000 for each $20,000 job saved • Restriction on Japanese cars • Cost $160,000/year for each job saved

35. Arguments Against Free Trade • The cost of protecting U.S. jobs • Glass industry restrictions • Cost $200,000/year per job saved • Steel industry restrictions • Cost $750,000/year per job saved

36. Emerging Arguments Against Free Trade • Environmental concerns • Genetic engineering and accidental production of new diseases • National defense

37. Ways to Restrict Foreign Trade • Quota System • A government-imposed restriction on the quantity of a specific good that another country is allowed to sell in the United States

38. Ways to Restrict Foreign Trade • Voluntary quotas • Voluntary Restraint Agreement (VRA) • An official agreement with another country that “voluntarily” restricts the quantity of its exports • Voluntary Import Expansion (VIE) • An official agreement with another country in which it agrees to import more from the United States

39. Supply with import quotas S E 2 1.50 E 1.00 1 D 800 900 The Effects of Quotas on Textile Imports Equilibrium without restrictions Price per Yard of Imported Textiles ($) 0 Quantity of Textiles Imported per Year Figure 33-4 (millions of yards)

40. Ways to Restrict Foreign Trade • Tariffs • Tax on imported goods • An import tariff benefits import-competing industries and harms consumers by raising prices.

41. S 2 $500 tariff S 1 E 1,250 2 1,000 E 1 D 8 10 The Effect of a Tariff on Japanese-Made Laptop Computers Panel (a) Japanese-Made Laptops Price per Laptop ($) 0 Japanese-Made Laptops (millions) Figure 33-5, Panel (a)

42. S E 1,250 2 1,000 E 1 D 2 D 1 5.0 6.5 The Effect of a Tariff on Japanese-Made Laptop Computers Panel (b) American-Made Laptops Price per Laptop ($) 0 U.S.-Made Laptops (millions) Figure 33-5, Panel (b)

43. Tariff Rates in theUnited States Since 1820 Figure 33-6 Source: U.S. Department of Commerce

44. Ways to Restrict Foreign Trade • Current tariff laws • Trade Expansion Act of 1962 • Trade Reform Act of 1974 • Trade and Tariff Act of 1984 • General Agreement on Tariffs and Trade (GATT) of 1947

45. Ways to Restrict Foreign Trade • The World Trade Organization (WTO) • Uruguay Round • Replaced GATT in the role of negotiating trade disputes • 147 member nations

46. Ways to Restrict Foreign Trade • Regional trade blocs • Groups of countries who grant trade preferences amongst themselves • Examples • European Union • NAFTA

47. Issues and Applications:Agricultural Subsidies Derail the WTO • Within the WTO, there is concern about the effect of agricultural subsidies paid by the developed nations to their farmers. • These subsidies have the effect of allowing food items exported from developed countries to serve as stiff competition for similar items produced elsewhere in the world.

48. Summary Discussion of Learning Objectives • Worldwide importance of international trade • World trade had grown faster than total world GDP • Why nations can gain from specialization in production and engaging in trade • Comparative advantage

49. Summary Discussion of Learning Objectives • Comparative advantage versus absolute advantage • Comparative advantage • Production by one nation at a lower opportunity cost than another • Absolute advantage • A nation can produce more with a given set of resources than can another

50. Summary Discussion of Learning Objectives • Arguments against free trade • Infant industry • Dumping • Environmental concerns • National defense • Ways that nations restrict foreign trade • Tariffs • Quotas