Chapter 37 International Trade Gains from Trade/Terms of Trade Absolute and Comparative Advantage Supply & Demand of Imports & Exports Trade Barriers

Which country is the U.S.A.’s largest trading partner? Foreign Trade - U.S. Trade

The Economic Basis for Trade Why do nations trade? 1) the distribution of economic resources—natural, human, and capital goods—among nations is uneven. 2) the efficient production of various goods requires different technologies or combinations of resources. 3) differentiation in quality and other nonprice attributes.

Basically, there are 3 types of goods 1) labor intensive goods (electronics, textiles, shoes, toys)…which country example? 2) land intensive goods (farming, wheat, meat, coffee, rice)…which country? 3) capital intensive goods (machinery, automobiles)…which country?

Absolute Advantage A nation has an absolute advantage relative to another nation if it can produce more of a good or service with the same amount of resources. Example: The US can produce more steel and more semiconductors than China, therefore USA has an absolute advantage in both. So why should it trade with China?

Comparative Advantage A nation has a comparative advantage when it produces the good or service where it has the lowest domestic opportunity cost (even if it does not have an absolute advantage.) This leads to specialization! Total global output will be greatest, production will be most efficient.

Graphical Analysis Example Using production possibilities curves of two nations with the following assumptions for simplicity: Constant costs (straight line trade-off) Different costs (opportunity costs!) Example with Graph: USA and Brazil Easy question: which country has the absolute advantage?

Tougher question: which country has the comparative advantage? The principle of comparative advantage says that total global output will be greatest when each good is produced by that nation which has the lowest domestic opportunity cost for that good. Key principles: Be the low-cost producer. Give up less than your trading partner does to produce the good.

Terms of Trade Set up the ratios to determine the possible terms of trade. To engage in trade, a nation must be able to pay a lower cost for that good in the world market than it would pay domestically. What are the terms of trade for the U.S. and Brazil in our example?

Gains from trade Trading possibilities line—PPF revisited With trade, the exchange ratio for both nations improves (give up less!) Specialization based on comparative advantage results in a more efficient allocation of world resources and larger outputs of both products will be available to both nations.

With increasing costs (concave PPF), specialization is not absolute With increasing costs (concave PPF), specialization is not absolute. The more a nation specializes, the more it gives up. In our example, the U.S. would still trade wheat for coffee, but would still produce some coffee (Kona!)

Supply & Demand of M and X The quantity of a good or service a nation will export/import depends on differences between the equilibrium world price and the equilibrium domestic price. When economies are opened for trade, these price differences motivate M and X.

Two Nation Example For simplicity: no tariffs, quotas or transportation costs Graph: U.S. Export & Import S & D Graph: S & D in China Graph: Equilibrium World Price—only one price for a standardized commodity can exist in a highly competitive world market.

Trade Barriers Tariffs—excise taxes on imported goods Revenue tariff—applied to products not domestically produced to generate revenue. Protective tariff—applied to products to protect domestic producers from foreign competition

Trade Barriers (con’t) Import Quota—maximum amount of a product that may be imported in a given period. Nontariff Barriers—licenses, unreasonable standards Voluntary Export Restriction (VER)—foreign firms voluntarily restrict exports.

Economic Impact of Tariffs Graph: Direct Effects 1. Decline in consumption 2. Increase in domestic production 3. Decline in imports 4. Revenue to govt. Indirect Effects—expansion of inefficient industries lacking a Comp. Adv. (and vice versa)

Economic Impact of Quotas Same as tariffs!! With one exception: quotas generate revenue for foreign producers whereas tariffs generate revenue for the govt. that imposes them.