1. International Trade
ECO 285 – Macroeconomics – Dr. D. Foster

2. International Trade Basis for trade: Comparative Advantage
Who has the lower “opportunity cost?”
Mistaken basis for trade: Absolute Advantage
Who has the lower resource cost?

3. Example: Absolute Advantage
Consider Senegal and Peru:
Who can more cheaply produce wool?
Who can more cheaply produce beef?
# = pounds

4. Example: Comparative Advantage
Reconsider Senegal and Peru:
What does it “cost” to produce wool?
What does it “cost” to produce beef?

5. Comparative Advantage
Opportunity costs in Senegal and Peru:
With trade, wool would “sell” for . . .?
With trade, beef would “sell” for . . .?
Price = Terms of Trade; say 1# W=2# B

6. Trade Observations Not all countries have absolute advantages.
All countries do have comparative advantages.
Country size is irrelevant.
Opportunity cost = what you give up.
The international trading price of goods is called the “terms of trade.”
Back to Senegal/Peru trade example:
Assume without trade, resources are split evenly.
Senegal always wants 50,000 #B;
Peru always wants 25,000 #W.

7. Advantages to Trade A - the “no trade” outcome; production=consumption
#Wool
#Wool
Senegal
Peru B
40,000
50,000 A A
50,000
20,000
25,000
37,500 B #
Beef #
Beef
100,000
75,000
A - the “no trade” outcome; production=consumption
B - the specialized production outcome, with trade

8. Advantages to Trade A - the “no trade” outcome; production=consumption
#Wool
#Wool
Senegal
Peru B
40,000
50,000 C
50,000
25,000 C
50,000
25,000 B #
Beef #
Beef
100,000
75,000
A - the “no trade” outcome; production=consumption
B - the specialized production outcome, with trade
C - the consumption outcome, with trade.

9. Advantages to Trade
Before trade, world production was: Wool: 45,000 lbs. Beef: 87,500 lbs.
With trade, world production has become: Wool: 50,000 lbs. Beef: 100,000 lbs.
Gains to trade: Wool: +5,000 lbs. Beef: +12,500 lbs.

10. Effects of Trade Barriers
In Senegal, unrest among the shepherds.
Workers must relocate.
Owners must relocate.
Politicians seek to “protect” domestic producers. Here, wool . . .
Consider a trade barrier – an import quota.

11. Policy - Import Quota Limit imports to 10,000 pounds of wool.
Senegal
#Wool
Peru
They can only trade 20,000#, so they only produce 70,000# B.
Use remaining resources to produce 12,000 # W.
They can only trade 10,000#, so they only produce 35,000#.
40,000
50,000
This takes 70% of their RUs, so rest is used to produce beef.
Trade 20,000# B for 10,000# W. Q
They can only get 20,000# B in trade. Q*
35,000
22,000
25,000 Q* Q
12,000 #
Beef #
Beef
100,000
75,000
50,000
22,500
70,000
42,500
Limit imports to 10,000 pounds of wool.
Now, neither can completely specialize.
Each has a lower standard of living.
World production:
Wool: 47,000#
Beef: 92,500#

12. Advantages to Trade & Disadvantages to Trade Barriers
Before trade, world production was: Wool: 45,000 lbs. Beef: 87,500 lbs.
With trade, world production was: Wool: 50,000 lbs. Beef: 100,000 lbs.
With quota, world production was: Wool: 47,000 lbs. Beef: 92,500 lbs.

13. International Trade Basis for trade: Comparative Advantage
Who has the lower “opportunity cost?”
Every country has a C.A. in some good.
Mistaken basis for trade: Absolute Advantage
Who has the lower resource cost?
Not every country has an A.A. in some good.

14. Trade Lessons We trade on the basis of our comparative advantage.
Everyone has a comparative advantage.
Trade raises our material standard of living.
Trade barriers lower our standard of living.
Responding to trade barriers in kind makes us worse off.

15. Trade Barriers Import quotas to keep foreign goods out.
Tariffs that serve as a tax on foreign goods.
Subsidies for producers of export goods.
Impose standards on foreign goods ( costs).
The false rhetoric of protection: cheap foreign labor, infant industry, national defense, beggar-thy-neighbor

16. Bob Murphy on the 5 most common myths about free trade.
We have free trade.
When our “free” trade bills are 1000 pages …
Trade deficits are bad.
The trade flow is equally offset by the capital flow.
Trade only helps poorer countries.
Does “Buy American” make us richer? Not “us!”
Free trade destroys jobs.
Odd sentiment vis-á-vis Texas & Mexico; Bastiat & candlemakers.
Free trade creates jobs.
No, it raises average wages and our standard of living.

17. aka Merchandise Trade Balance
Trade Fundamentals
We have different categories of trade:
Goods
Services
Financial Account
Value of assets.
Net change in securities.
Other.
Balancing error
aka Merchandise Trade Balance
Net Exports,
“Current Account”,
aka Trade Balance
Balance of Payments
9/18: – =
Exports - Imports = Deficit
Goods
Ex Im
Services
Ex Im
Trade balance
Sept 2018: (141.9 b – b) + (70.7 b – 47.5 b)
= = b

18. Balance of Trade
Exports
Imports
Sept. 2018
millions of $

19. Trade Fundamentals
Financial Account
Current Account

20. The Role of Trade in the Government’s Budget
Recall from the circular flow, spending = income
GDP = NI
C + I + G + (Ex-Im) = C + S + T
Rearrange: G = T + (S-I) + (Im-Ex)
All government spending comes from:
Tax revenue raised.
Net private sector savings.
Net foreign sector savings. [i.e., the trade deficit]
Or, (G-T) = (S-I) + (Im-Ex)
The gov’t deficit = crowded out investment + trade deficit

21. International Trade
ECO 285 – Macroeconomics – Dr. D. Foster