Chapter 33: The Gains from International Trade Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 33.1The Gains from Trade 1.explain why the gains from trade depend on the pattern of comparative advantage. 2.understand how factor endowments and climate can influence a country's comparative advantage. 33.2The Determination of Trade Patterns 3.describe the law of one price. 4.explain why countries export some goods and import others. Copyright © 2014 Pearson Canada Inc. 2 Chapter 33, Slide

Fig The Growth in World Trade, 1950– Copyright © 2014 Pearson Canada Inc. Chapter 33, Slide

Fig Canadian Exports and Imports of Goods by Industry, Copyright © 2014 Pearson Canada Inc. Chapter 33, Slide

33.1The Gains from Trade Interpersonal, Interregional, and International Trade Without trade, people must be self-sufficient. With trade, people can specialize efficiently and satisfy other needs by trading. This basic principle is true for individuals, regions, and countries:  the gains from trade Copyright © 2014 Pearson Canada Inc. 5 Chapter 33, Slide

Factor endowment An advantage in production comes from better skills, equipment, or other resources Theory of absolute advantage Nations, like firms and individuals, should specialize in producing goods and services for which they have an advantage They should trade for goods and services for which they do not enjoy an advantage 10-6 © 2012 McGraw-Hill Ryerson Limited LO1 Specialization and Trade

Self-Test 1 a)Which country should specialize in which product? b)Suppose that initially the working population of each country is 20 million, with 10 million working in each industry. What is the total output of the two countries? c) Suppose that each country decides to specialize in the product in which it has an advantage. What will be the total output of each product, and what are the gains from trade? © 2012 McGraw-Hill Ryerson Limited 10-7 LO1 BeerWine Freedonia41 Libraland34

Theory of comparative advantage the advantage that comes from producing something at a lower opportunity cost than others are able to do 10-8 © 2012 McGraw-Hill Ryerson Limited LO2 Specialization and Trade

Comparative Advantage Each country has a trade-off (opportunity cost) for each item it produces LO2 © 2014 McGraw-Hill Ryerson Limited 10- 9

Production Without Trade Suppose the United States produces at C, while the Philippines produces at B (no trade) LO2 © 2014 McGraw-Hill Ryerson Limited

Specialization With Trade Suppose the United States specializes at A, while the Philippines specializes at F, and they trade LO2 © 2014 McGraw-Hill Ryerson Limited

Illustrating the Gains from Trade Canada specializes in wheat; the EU specializes in cloth.  consumption possibilities increase in both countries Copyright © 2014 Pearson Canada Inc. Fig The Gains from Trade with Constant Opportunity Costs 12 Chapter 33, Slide

Our conclusions are: 1.If Canada has a comparative advantage in one product then it must have a comparative disadvantage in another. 2.When opportunity costs are the same in all countries, there are no gains from specialization and trade. 3.When opportunity costs differ across both countries, global production can be increased by reallocating resources. Copyright © 2014 Pearson Canada Inc. APPLYING ECONOMIC CONCEPTS 33-1 Two Examples of Absolute and Comparative Advantage 13 Chapter 33, Slide

The Gains from Trade with Variable Costs Additional gains from trade may be possible: Economies of scale: International trade allows small countries to produce high enough levels of output to reap the available scale economies. Learning by doing: Costs may also fall as production experience increases. Copyright © 2014 Pearson Canada Inc. 14 Chapter 33, Slide

Fig Economies of Scale Versus Learning by Doing Scale economies are shown by the downward sloping LRAC curve. Learning by doing implies that LRAC curves shift down as experience increases. Copyright © 2014 Pearson Canada Inc. 15 Chapter 33, Slide

Sources of Comparative Advantage Factor endowments. Countries have the CA in products that use their abundant resources relatively intensively. Climate. Variation in national climates affects comparative advantages. Climate can be considered a "special" factor of production. Human capital. People can acquire skills that influence a country's comparative advantage. Dynamic. Comparative advantage can be acquired or lost over time. It is a dynamic concept. Copyright © 2014 Pearson Canada Inc. 16 Chapter 33, Slide

33.2The Determination of Trade Patterns The Law of One Price when an easily transported product is internationally traded, arbitrage will guarantee a single world price Compare the world price with the Canadian autarkic price: 1.If p w > p d  Canada exports the product 2.If p w < p d  Canada imports the product Copyright © 2014 Pearson Canada Inc. 17 Chapter 33, Slide

The Patterns of Foreign Trade Countries export goods whose world price exceeds the autarkic price.  Countries export the goods for which they are low-cost producers. Copyright © 2014 Pearson Canada Inc. Fig An Exported Good 18 Chapter 33, Slide

The Patterns of Foreign Trade Countries import products whose world price is less than the autarkic price.  Countries import goods for which they are high-cost producers. Copyright © 2014 Pearson Canada Inc. Fig An Imported Good 19 Chapter 33, Slide

Is Comparative Advantage Obsolete? The theory that comparative advantage determines trade flows is not obsolete. But the idea that CA is completely determined by forces beyond the reach of public policy has been discredited. Although governments may influence patterns of CA, it is not necessarily advisable: compare the costs of trade-related policies with their likely benefits Copyright © 2014 Pearson Canada Inc. 20 Chapter 33, Slide

APPLYING ECONOMIC CONCEPTS 33-2 Comparative Advantage and Global Supply Chains The Terms of Trade The division of the gains from trade depends on the terms of trade. The terms of trade are measured by the ratio of the price of exports to the price of imports. 21 Copyright © 2014 Pearson Canada Inc. Terms of Trade = Index of Export Prices Index of Import Prices x 100 Chapter 33, Slide

A rise in the index:  country gets more imports per unit of exports  a favourable change for the country A fall in the index:  country gets fewer imports per unit of exports  an unfavourable change for the country Copyright © 2014 Pearson Canada Inc. 22 Chapter 33, Slide

Fig Canada's Terms of Trade, 1961–2012 Copyright © 2014 Pearson Canada Inc. 23 Chapter 33, Slide