 Who can produce more freezers?  Germany  Who can produce more dishwashers?  Germany Therefore, Germany has an absolute advantage in the production of both freezers and dishwashers, simply because they can produce more than Italy.

 So should Germany and Italy trade?  To answer this, we must look at opportunity cost. Germany Cost of producing 1 freezer = ½ dishwasher Cost of producing 1 dishwasher = 2 freezers Italy Cost of producing 1 freezer = ¼ dishwasher Cost of producing 1 dishwasher = 4 freezers

 When Germany decides to produce 1 freezer, it forgoes the opportunity to produce ½ of a dishwasher.  When Italy decides to produce 1 freezer, it forgoes the opportunity to produce ¼ of a dishwasher.  Which nation gives up the least, or has the lowest opportunity cost, when they produce 1 freezer?  Italy Germany Cost of producing 1 freezer = ½ dishwasher Cost of producing 1 dishwasher = 2 freezers Italy Cost of producing 1 freezer = ¼ dishwasher Cost of producing 1 dishwasher = 4 freezers

 When Germany decides to produce 1 dishwasher, it forgoes the opportunity to produce 2 freezers.  When Italy decides to produce 1 dishwasher, it forgoes the opportunity to produce 4 freezers.  Which nation gives up the least, or has the lowest opportunity cost, when they produce 1 dishwasher?  Germany Germany Cost of producing 1 freezer = ½ dishwasher Cost of producing 1 dishwasher = 2 freezers Italy Cost of producing 1 freezer = ¼ dishwasher Cost of producing 1 dishwasher = 4 freezers

 A country is said to have a comparative advantage in whichever good has the lowest opportunity cost.  If Italy specializes in the production of freezers and Germany specializes in the production of dishwashers, more freezers and dishwashers will be able to be produced.  Then the nations can trade for each other’s goods.  In the end, both nations will be able to consume more freezers and dishwashers than they could have with no trading.

 Recall our equation for GDP: GDP = C + I + G + NX NX stands for net exports and could be written as (X-M), or (exports – imports). If a nation subtracts the value of its imports from the value of its exports and ends up with a positive number, then that nation has a trade surplus. If a nation subtracts the value of its imports from the value of its exports and ends up with a negative number, then that nation has a trade deficit.

 The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries.  The balance of payments includes the current account (trade in merchandise/services), the capital account (trade in capital), and the financial account (flows related to investment in business, real estate, bonds and stocks). Note: a country could have a trade deficit and a balance of payments surplus. Table 1 The U.S. Balance of Payments, 2004

 Tariff: a tax on imported goods  Quota: a limit on the number of a specific good that can come into a country from another country  Embargo: a ceasing of all trade … no imports, no exports  Standards: regulations in one country that keep goods from another nation out (environmental or safety standards)  Subsidies: government payments to business to help them pay for the costs of production … seen as a barrier to trade b/c it gives the subsidized industry an unfair advantage in global markets

 Tariffs, quotas, embargoes, and standards have the same effect – supply falls and prices rise.  Subsidies lower the cost of production for domestic producers, causing supply to increase and prices to decrease. b. Identify costs and benefits of trade barriers over time.

 For trade barriers:  Infant industries argument: If a nation has developing industries, it must protect them from competition from well-established businesses in other countries that can produce more efficiently.  National security argument: Certain industries, such as steel and energy, are of vital importance to a nation’s national security and thus must be protected.  Dependency argument: A nation should not allow itself to become too dependent on other nation’s for its own well-being.

 Against trade barriers:  Efficiency argument: Specialization and trade is more efficient. A nation should not support an industry that is inefficient – this is a waste of resources.  When nations specialize and trade, both parties gain. Production and consumption increase, as does standard of living. Erecting barriers to free trade deprives nations of these benefits of trade.

 European Union (EU): a monetary union (the euro) of most of the nations of Europe designed to make trade easier  North American Free Trade Association (NAFTA): an association between the nations of North America (US, Canada, Mexico) designed to limit trade barriers  Association of Southeast Asian Nations (ASEAN): free trade association of SE Asian nations

European Union (EU)

NAFTA

ASEAN