CHAPTER 19 – INTERNATIONAL TRADE (6e)

I.Gains from Trade

(Omit “Production Possibilities Without Trade” and “Consumption Possibilities Based on Comparative Advantage” on pp. 404-408. Exhibits 2, 3, and 4 on those pages may also be omitted. Regarding “Gains from Trade”, you will only be responsible for knowing the information presented in class and included in your notes.)

We will examine the gains that countries can enjoy from specializing in the production of certain goods/services and then trading with other countries.

To understand what will be covered in this section, you must go back to Chapter 2 and review the concepts of absolute advantage, comparative advantage, opportunity cost, and the law of comparative advantage.

A.Trade Based on Comparative Advantage

Absolute advantage:

Comparative advantage:

Law of comparative advantage:

Example:

1 Car / 1 Computer
U.S. / 800 hrs. / 100 hrs.
Japan / 200 hrs. / 40 hrs.

Japan has the absolute advantage in production of both cars and computers.

Does Japan have anything to gain from trade with the U.S.? YES, because gains from trade are based not on absolute advantage but on comparative advantage.

How to measure opportunity cost and determine comparative advantage:

In the U.S., the opportunity cost of producing one more car is ______. Conversely, the opportunity cost of producing one more computer in the U.S.is ______.

In Japan, the opportunity cost of producing one more car is ______. Conversely, the opportunity cost of producing one more computer in Japanis ______.

The law of comparative advantage holds that each country should specialize in the good for which it has the lower opportunity cost.

To produce 1 car, the U.S. gives up 8 computers, while Japan gives up only 5 computers. Thus Japan has the comparative advantage in cars. So Japan should specialize in producing cars (and then export some to the U.S.).

To produce 1 computer, the U.S. gives up only 1/8 of a car, while Japan gives up 1/5 of a car. Thus the U.S. has the comparative advantage in computers. So the U.S. should specialize in producing computers (and then export some to Japan).

Before the U.S. and Japan can trade, they must decide on the terms of trade.

Definition of terms of trade (p. 406):

Remember the opportunity costs:

In the U.S.: 1 car = 8 computers

In Japan: 1 car = 5 computers

OR

In the U.S.: 1 computer = 1/8 car

In Japan: 1 computer = 1/5 car

It will be beneficial for both countries if 1 car is traded for anything between 5 and 8 computers, or if 1 computer is traded for anything between 1/8 and 1/5 of a car.

Thus, for example, mutually beneficial terms of trade might be:

1 car = 6 computers

OR

1 computer = 1/6 car

How would this be beneficial to both countries?

Examples:

The U.S. could produce 8 computers in 800 hours, trade 6 of the computers to Japan for 1 car, and keep the other 2 computers. (Remember that if the U.S. used those 800 hours to produce the car, it would end up with only 1 car and no computers.)

Japan could produce 1 car in 200 hours and trade it to the U.S. for the 6 computers. (Remember that if Japan used those 200 hours to produce computers, it would end up with only 5 computers.)

CONCLUSION: By following the law of comparative advantage, countries can realize gains from trade.

B.Reasons for International Specialization

Read this section on pp. 408-409 to understand how countries are prompted to produce and trade specific goods as a result of:

1)Differences in resource endowments

2)Economies of scale

3)Differences in taste

  1. Trade Restrictions and Welfare Loss

(Omit Ex. 5 and Ex. 6 and all material on pp. 409-413 that relates to those exhibits. From those pages you will only be responsible for knowing the information presented in class and included in your notes.)

Impediments to free trade are often erected by nations. We will look briefly at the most common barriers to trade, who benefits from them, and who is harmed by them.

A.Tariffs

Tariff: a tax on imports.

  • Consumers are made worse off because the tax raises the price of the imported good.
  • Domestic producers benefit by being able to raise their prices without losing customers to imported goods.
  • The government collects the tariff; how these funds are used (to cut other taxes, reduce the national debt, provide more government services) determines who will benefit from the government’s higher revenues.
B.Import Quotas

Import quota: a limit on the quantity of a good that can be imported.

  • Consumers are made worse off because the quota causes the good to be scarcer domestically, leading to a higher price.
  • The foreign exporters who can fill the quota and sell the good at a higher price will benefit.
  • The domestic producers benefit because they are better protected from foreign competition andcan now sell their output at a higher domestic price.
C.Other Trade Restrictions

Read this section on pp. 413-414. Be familiar with the trade-restricting measures mentioned: export subsidies, low-interest loans, domestic content requirements, health/safety standards, etc.

D.Freer Trade by Multilateral Agreement

1)GATT

The General Agreement on Tariffs and Trade was an international trade treaty adopted in 1947 and signed by 23 countries, including the U.S.

GATT members agreed to treat all member nations equally with respect to trade, negotiate tariff reductions, and reduce import quota.

2)WTO

The World Trade Organization succeeded GATT in 1995; it is a permanent institution headquartered in Geneva. The WTO provides a platform for collective debate on trade relations among member countries. Goals include eliminating all quotas and reducing tariffs among participating countries.

3)Common Markets

Read on pp. 416-417 about NAFTA, the European Union, and other trading blocs.

III.Arguments for Trade Restrictions

Although consumers are typically made worse off by trade restrictions, some industries, politicians, unions, etc., advocate imposing or extending such restrictions.

Read pp. 417-420. Be familiar with each of the following arguments for trade restrictions, as well as the counterarguments.

  1. National Defense Argument

B.Infant Industry Argument

C.Antidumping Argument

  1. Jobs and Income Argument

E.Declining Industries Argument

END

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