1. Gaining from International Trade
Chapter 18

2. Chapter 18 Objectives
Comprehend why specialization and trade generate gains.
Describe the kinds of trade barriers and their effects.
Recognize reasons for implementing trade restrictions.
Clear up common misconceptions of international trade.

3. The Growth of the U.S. Trade Sector
Imports (% of GDP) 20 15 10
As is shown here, both exports & imports have grown substantially as a share of the U.S. economy during the last several decades. Their growth has accelerated since 1980.
Reductions in both transportation and communication costs, as well as lower trade barriers have contributed to this growth. 5
1960
1970
1980
1990
2000
2010
Exports (% of GDP) 20 15 10 5
1960
1970
1980
1990
2000
2010

4. Leading Trade Partners of the U.S.

5. Trade and Comparative Advantage
Comparative advantage – the ability to produce a good at a lower opportunity cost than others.
Relative costs determine comparative advantage
As long as relative costs differ, gains from trade are possible!

6. Absolute Advantage
Absolute advantage – a nation can produce more of a good (with the same amount of resources) than another nation
Trade isn’t based on absolute advantage for individuals or countries

7. Opportunity Cost Jessica can gain if specialize in Fish
Output Per Day
Fish
Apples
Jessica 50 OR
Winston
100
200
Opportunity Costs
Of 1 Fish
Of 1 Apple
Jessica
1 Apple
1 Fish
Winston
2 Apples
½ Fish
Jessica can gain if specialize in Fish
Winston can gain if specialize in Apples

8. Jessica’s PPC: No Trade
Jessica decides to make 25 fish and 25 apples 50
Apples 25 25 50
Fish

9. Winston’s PPC: No Trade
Winston decides to make 50 fish and 100 apples
200
Apples
100 50
100
Fish

10. They Decide to Trade! Production
Jessica specializes in fish: 50 fish, 0 apples
Winston specializes in apples: 25 fish, 150 apples
Their agents and lawyers talk and it’s mutually agreed that the two will trade 37 apples for 25 fish
Consumption
Jessica consumes: 25 fish, 37 apples
Winston consumes: 50 fish, 113 apples

11. Jessica’s Consumption Possibilities Curve74 50
Apples 37 25 25 50
Fish

12. Winston’s Consumption Possibilities Curve
200
Apples
113
100 50
100
270
Fish

13. Law of Comparative Advantage
Trade between nations leads to
An expansion in total output
Gains for each trading partner
Higher incomes for both nations

14. Gains from International Trade
1. Gains from large-scale production
2. Gains from more competitive markets
3. More pressure to adopt sound institutions

15. World Price > Domestic Price
If the world price is higher than the domestic price, the domestic country has a comparative advantage in producing the good
The domestic country as a whole will benefit if they export the good

16. World Price > Domestic Price No Trade Outcome
Consumer Surplus
Price S
World Price
Producer Surplus
Price w/o
trade D
Quantity
Equilibrium Quantity

17. World Price > Domestic Price Trade Outcome
Consumer Surplus
Price S
Price w/
trade
World Price
Producer Surplus D
Quantity
Quantity Consumed
Quantity Produced
Amount Exported

18. World Price > Domestic Price Trade Outcome
Total gains from
Trade!
Price S
Price w/
trade
World Price D
Quantity
Quantity Consumed
Quantity Produced
Amount Exported

19. Impact of Exporting Domestic price will rise to world price
Domestic producers of the good  winners 
Domestic consumers of the good  losers 
Country overall  gains to producers are greater than losses to consumers! 

20. World Price < Domestic Price
If the world price is less than the domestic price, another country has a comparative advantage in producing the good
The domestic country will benefit if they import the good

21. World Price < Domestic Price No Trade Outcome
Consumer Surplus
Price S
Producer Surplus
Price w/o
trade
World Price D
Quantity
Equilibrium Quantity

22. World Price < Domestic Price Trade Outcome
Consumer Surplus
Price S
Producer Surplus
Price w/
trade
World Price D
Quantity
Quantity Consumed
Quantity Produced
Amount Imported

23. World Price < Domestic Price Trade Outcome
Total Gains
From Trade!
Price S
Price w/
trade
World Price D
Quantity
Quantity Consumed
Quantity Produced
Amount Imported

24. Impact of Importing Domestic price will fall to world price
Domestic producers of the good  losers 
Domestic consumers of the good winners 
Country overall 
Winners!
Gains to consumers are greater than losses to producers
But producers’ losses are visible
Consumers gains are harder to see

25. Trade Openness, Income, and Growth
10 Most Open
Economies,
2005 GDP per capita
Growth rate
TOI
Hong Kong
10.0
$ 30,989
3.9 %
Singapore
9.9
$ 26,390
4.3 %
Bahrain
8.6
$ 19,112
1.0 %
Belgium
8.6
$ 28,575
1.7 %
Malaysia
8.6
$ 9,681
3.6 %
The income levels and growth rates of the ten most and ten least open economies (as measured by the Trade Openness Index – TOI) are displayed here.
Note that more open economies both achieved higher income levels and grew more rapidly.
U.S. ranked 16th
Luxembourg
8.5
$ 53,583
3.7 %
Netherlands
8.4
$ 29,078
1.6 %
Taiwan
8.4
$ 20,868
5.1 %
Ireland
8.1
$ 34,256
4.5 %
Australia
7.9
$ 29,981
1.9 %
Average:
8.7
$ 28,251
3.1 %
10 Least Open Economies,
2005 GDP per capita
Growth rate
TOI
India
4.3
$ 3,072
4.0 %
Tanzania
4.1
$ 662
2.3 %
Egypt
4.1
$ 3,858
2.5 %
Pakistan
3.9
$ 2,109
2.4 %
Syria
3.8
$ 3,388
0.6 %
Algeria
3.4
$ 6,283
0.5 %
Sierra Leone
3.4
$ 717
- 1.1 %
Burundi
3.0
$ 622
- 1.0 %
Sources: TOI data are from Charles Skipton, The Measurement of Trade Openness. Doctoral Dissertation, Florida State University, Per capita GDP & growth data are from The World Bank, World Development Indicators, CD-ROM, 2004.
Iran
2.9
$ 7,089
1.1 %
Bangladesh
2.5
$ 1,827
2.2 %
Average:
3.5
$ 2,963
1.4 %

26. Economics of Tariffs
Tariff – a tax levied on goods imported into a country
Smoot-Hawley Tariff Act 1930 – 60%
2008 – 4%
Benefits domestic producers and government
Hurts domestic consumers!
Causes deadweight loss
Encourages lobbying by domestic producers

27. Economics of Quotas
Import quota – a specific limit or maximum quantity of a good permitted to be imported into a country during a given period
U.S.: peanuts, sugar, brooms, shoes
Benefits domestic and some foreign producers
Hurts domestic consumers!
Causes deadweight loss
Encourages lobbying by producers

28. Trade Restrictions Create special interest groups
Prevent voluntary exchanges
Reduce overall output, cause deadweight loss

29. Arguments Against Free Trade
If trade is good, why to nations adopt restrictions?
Arguments Against Free Trade
National-Defense
Infant-Industry
Antidumping
Politics of Trade Restrictions

30. National Defense Argument
Trade Opponents Say: Certain industries are vital to our national defense
Reality:
This argument is often abused
Government could buy and store resource during peacetime
Economic growth is part of a strong defense

31. Infant-Industry Argument
Trade Opponents Say: New domestic industries just need a chance to develop
Reality:
Once protection is granted, difficult to remove
Over 100 years ago sugar quotas, manufacturing tariffs, and steel tariffs were put into place

32. Antidumping Argument
Trade Opponents Say: Foreign producers will cut prices to drive out competition, then use power to gouge consumers
Reality:
Firms can re-enter industry
Competition keeps prices low
Dumping – selling a good in a foreign country at a lower price than it’s sold for in the domestic market

33. Special Interests
Trade restrictions provide visible benefits for a few while spreading the costs over many
U.S. tariff code
3,091 pages
High tariffs on some goods
Low tariffs on others
Confusing to understand
Very costly to administer!

34. Trade Truth Cannot decrease imports w/o decreasing demand for exports
Reason:
Tariffs and quotas cause $ to appreciate
This makes exports fall

35. Trade Fallacies Myth: Trade restrictions that limit imports save jobs
Truths:
Trade restrictions increase employment in protected industries
Trade restrictions destroy jobs in domestic sectors that export
Trade restrictions hurt domestic consumers and producers via higher prices
Restrictions reshuffle jobs, reduce incomes

36. Trade Fallacies
Myth: Free trade with low-wage countries will reduce U.S. wages
Truths:
Lower prices increase consumers’ purchasing power
Source of wage difference is productivity difference
Trade between a doctor and a housekeeper doesn’t lower doctor’s wages!

37. Global Trade World Trade Organization (WTO)
New name for GATT in 1994;
Responsible for monitoring trade agreements among 153 member countries
Average tariff rate fell from 40% in 1947 to 3%
North American Free Trade Agreement (NAFTA)
1994 trade agreement among U.S., Canada and Mexico
Eliminated most tariffs

38. Chapter 18 Objectives
Comprehend why specialization and trade generate gains.
Describe the kinds of trade barriers and their effects.
Recognize reasons for implementing trade restrictions.
Clear up common misconceptions of international trade.