1. Free Trade Theory
Why Nations Trade

2. Basics of Trade Exports: goods/services leave country
Defined: 2 Countries engage in economic activity
Exports: goods/services leave country
Imports: goods/services enter country
Trade Surplus: Export more than import
Trade Deficit: Import more than export

3. Why Trade?

4. Ways to Limit Trade Tariffs– taxes on imports
Quotas- limits on quantity imported
Protectionism: Gov’t policy which seeks to limit trade
Globalization: the “global” movement towards free trade
Trade without Tariffs & Quotas
free market capitalism on a global scale

5. Adam Smith
In his 1776 book Wealth of Nations, Adam Smith talked about specialization

6. Adam Smith on Specialization
When each worker made
their own pins, they produced pins per day each
Adam Smith noted that when each worker specialized in a production
stage, the output by the factory
increased to 4,800 pins per worker
(Page 11, Wealth of Nations)
Also known as Division of Labor

7. + Specialization works! Idaho Florida Texas Nevada
Any illegal activity you can think of…

8. David Ricardo
In his 1816 book David Ricardo developed the free trade theory based on comparative advantage
Absolute Advantage: when a country can produce a good more efficiently
produce a good using fewer resources
Comparative Advantage: when a country can produce a good at a lower opportunity cost
country gives up less when they produce a good

9. Ricardo’s Trade Theory
Here is my great theory!
Ricardo’s Trade Theory
Countries should produce (specialize) in goods where they have a comparative advantage
Trade benefits both parties (each country gets “more”)
Free Trade promotes a more “efficient” world economy
Absolute Advantage is not relevant in deciding which country should produce a good

10. Practice Problems