1. TOPIC 11
INTERNATIONAL TRADE

2. International Trade
All economies, regardless of their size, depend to some extent on other economies and are affected by events outside their borders.

3. The Economic Basis for Trade: Comparative Advantage
A country enjoys a comparative advantage in the production of a good when that good can be produced at a lower cost in terms of other goods.

4. Absolute Advantage versus Comparative Advantage
A country enjoys an absolute advantage over another country in the production of a product when it uses fewer resources to produce that product than the other country does

5. Gains from Mutual Absolute Advantage
Yield Per Acre Of Wheat And Cotton
NEW ZEALAND
AUSTRALIA
Wheat
6 bushels
2 bushels
Cotton
2 bales
6 bales
New Zealand can produce three times the wheat that Australia can on one acre of land, and Australia can produce three times the cotton.
We say that the two countries have mutual absolute advantage.

6. Gains from Mutual Absolute Advantage
Suppose that each country divides its land to obtain equal units of cotton and wheat production as shown below:
Total Production Of Wheat And Cotton Assuming No Trade, Mutual Absolute Advantage, And 100 Available Acres
NEW ZEALAND
AUSTRALIA
Wheat
25 acres x 6 bushels/acre 150 bushels
75 acres x 2 bushels/acre 150 bushels
Cotton
75 acres x 2 bales/acre 150 bales
25 acres x 6 bales/acre 150 bales

7. Production Possibility Frontiers for Australia and New Zealand Before Trade

8. Gains from Mutual Absolute Advantage
An agreement to trade 300 bushels of wheat for 300 bales of cotton would double both wheat and cotton consumption in both countries.
Production and Consumption of Wheat and Cotton after Specialization
PRODUCTION
CONSUMPTION
New Zealand
Australia
Wheat
100 acres x 6 bu/acre 600 bushels
0 acres 0
300 bushels
Cotton
100 acres x 6 bales/acre 600 bales
300 bales

9. Expanded Possibilities after Trade
Because both countries have an absolute advantage in the production of one product, specialization and trade will benefit both.

10. Gains from Comparative Advantage
Even if a country had a considerable absolute advantage in the production of both goods, Ricardo would argue that specialization and trade are still mutually beneficial.

11. Gains from Comparative Advantage
Assume that people in each country want to consume equal amounts of cotton and wheat, and that each country is constrained by its domestic production possibilities curve, as follows:
Yield Per Acre of Wheat and Cotton
Wheat
NEW ZEALAND
AUSTRALIA
6 bushels
1 bushel
Cotton
6 bales
3 bales

12. Gains from Comparative Advantage
Total Production of Wheat and Cotton Assuming No Trade and 100 Available Acres
Wheat
NEW ZEALAND
AUSTRALIA
50 acres x 6 bushels/acre 300 bushels
75 acres x 1 bushels/acre 75 bushels
Cotton
50 acres x 6 bales/acre 300 bales
25 acres x 3 bales/acre 75 bales
The gains from trade in this example can be demonstrated in three stages.

13. Stage 1: Countries specialize
Realizing a Gain from Trade When One Country Has a Double Absolute Advantage
Stage 1: Countries specialize
Wheat
STAGE 1
New Zealand
Australia
50 acres x 6 bushels/acre 300 bushels
0 acres 0
Cotton
50 acres x 6 bales/acre 300 bales
100 acres x 3 bales/acre 300 bales
Australia transfers all its land into cotton production. New Zealand cannot completely specialize in wheat production because it needs 300 bales of cotton and will not be able to get enough cotton from Australia (if countries are to consume equal amounts of cotton and wheat).

14. Realizing a Gain from Trade When One Country Has a Double Absolute Advantage
Wheat
STAGE 2
New Zealand
Australia
75 acres x 6 bushels/acre 450 bushels
0 acres 0
Cotton
25 acres x 6 bales/acre 150 bales
100 acres x 3 bales/acre 300 bales
New Zealand transfers 25 acres out of cotton and into wheat.

15. Realizing a Gain from Trade When One Country Has a Double Absolute Advantage
STAGE 3
New Zealand
Australia
100 bushels (trade)
Wheat
350 bushels
100 bushels
(after trade)
200 bales (trade)
Cotton
350 bales
100 bales
Countries Trade

16. Gains from Comparative Advantage
The real cost of producing cotton is the wheat that must be sacrificed to produce it.
A country has a comparative advantage in cotton production if its opportunity cost, in terms of wheat, is lower than the other country.

17. Comparative Advantage Means Lower Opportunity Cost
Both Australia and New Zealand will gain when the terms of trade are set between 1:1 and 3:1, cotton to wheat.

18. Terms of Trade
The ratio at which a country can trade domestic products for imported products is the terms of trade.
The terms of trade determine how the gains from trade are distributed among trading partners.

19. Trade Barriers
Protection is the practice of shielding a sector of the economy from foreign competition.
A tariff is a tax on imports.
A quota is a limit on the quantity of imports.
Export subsidies are government payments made to domestic firms to encourage exports.
Dumping refers to a firm or industry that sells products on the world market at prices below the cost of production.

20. The Case for Protection
Protection saves jobs
Some countries engage in unfair trade practices
Cheap foreign labor makes competition unfair
Protection safeguards national security
Protection discourages dependency
Protection safeguards infant industries