1. U.S. barriers to international trade (tariffs and import quotas) reduce the general welfare of society in the U.S. Generally AgreeGenerally Disagree Economists92.6%5.8% Republicans57.6%41.1% Democrats49.7%45.1% Comparative Advantage Many Americans and members of Congress do not share the enthusiasm of economists and the recent administrations, however. Broadly speaking, economists support free trade: when polled, more than 90 percent of economists believe that trade restrictions reduce general economic welfare. During the last quarter century, American administrations have generally supported trade liberalization. The Clinton administration strongly advocated NAFTA (North American Free Trade Agreement) and pushed for freer trade in other international forums. The Bush administration urged Congress to pass fast-track authority that would allow the administration to negotiate agreements reducing trade barriers even more. The Obama administration recently completed the negotiation of the Trans-Pacific Trade Agreement with Australia, Canada, Japan, Malaysia, Mexico, Peru, Vietnam, Brunei, Chile, Singapore, New Zealand, and the United States. Some Recent History

2. NAFTA: North American Free Trade Agreement In a December 10, 1998 Wall Street Journal article, Jackie Calmes reported on the difficulties encountered by the administration in its efforts to promote free trade: “President Clinton keeps trying to sell the idea that foreign trade is good for the U.S. economy. Yet eight years into a record peacetime expansion, many Americans still aren’t buying.” “The latest poll for The Wall Street Journal and NBC News illustrates the hurdle faced by the administration and other free traders. Given a choice of statements, a lopsided 58% majority of those polled agreed that foreign trade has been bad for the U.S. economy because cheap imports have cost wages and jobs here. Just 32% said trade has been good because foreign demand for U.S. goods has spawned economic growth and produced jobs for Americans.” In a January 27, 1999 Wall Street Journal article, Michael M. Phillips also reported on the administration’s efforts: “Clinton’s top economic advisers went to Capitol Hill yesterday to present their free-trade agenda for the year - and left with a clear picture of how controversial that agenda will be.” Sen. Frank Murkowski (R. Alaska) complained that the glut of foreign oil has pushed down oil prices and cost jobs in the energy industry. … Most vehement was Democrat Sen. John D. “Jay” Rockefeller IV (D. W.Va.) who condemned what he called an illegal flood of cheap steel from Japan, Russia, Brazil and elsewhere.” “[But] Generally, … free trade benefits the nation as a whole …”

3. Puzzles: Is it true that “free trade benefits the nation as a whole” as Phillips writes? If so, why then do most Americans and many members of Congress oppose free trade? United StatesMexico 1 worker Wheat  200 bushels 1 worker Textiles  200 yards 1 worker Wheat  20 bushels 1 worker Textiles  100 yards Absolute Advantage U. S. has an absolute advantage in the production of wheat. U. S. has an absolute advantage in the production of textiles. Mr. A: “American workers are more productive than their Mexican counterparts; hence, trade with Mexico can only hurt the U. S.” Preview: Theory of Comparative Advantage Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. Trade: Furthermore, if, after specialization, each nation exports the good in which it enjoys a comparative advantage and consumers in each nation can have more goods available to enjoy. imports the good in which it suffers a comparative disadvantage Why?

4. Comparative Advantage: Opportunity Cost Is Crucial Opportunity Cost of Wheat United StatesMexico Wheat Production Textile Production  1 worker  Wheat Production Textile Production  1 worker  200 bushels of wheat cost 200 yards of textiles. 1 bushel of wheat costs 1 yard of textiles. 20 bushels of wheat cost 100 yards of textiles. 1 bushel of wheat costs 5 yards of textiles. U.S. has a comparative advantage in the production of wheat. Opportunity Cost of Textiles Wheat Production Textile Production Wheat Production Textile Production  1 worker  200 yards of textiles cost 200 bushels of wheat. 1 yard of textiles costs 1 bushel of wheat. 100 yards of textiles cost 20 bushels of wheat. 1 yards of textiles cost 1/5 bushel of wheat. Mexico has a comparative advantage in the production of textiles. United StatesMexico 1 worker Wheat  200 bushels 1 worker Textiles  200 yards 1 worker Wheat  20 bushels 1 worker Textiles  100 yards United StatesMexico 200 more bushels 200 fewer yards 20 more bushels 100 fewer yards  1 worker  200 fewer bushels 200 more yards 20 fewer bushels 100 more yards What must be given up or foregone when an activity is pursued. NB: Mexico has a comparative advantage in the production of textiles even though the U.S. has the absolute advantage.

5. Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. 1 worker Wheat  200 bushels 1 worker Textiles  200 yards 1 worker Wheat  20 bushels 1 worker Textiles  100 yards United StatesMexico Let us keep the worldwide production of textiles constant. Wheat Production Textile Production U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers World+1600 Mexico  40 +200 U.S.+200  200 Prod Wheat (bushels)Textiles (yards) Gains of specialization: 160 bushels of wheat. Question: How many workers should be moved to textile production in Mexico? Answer: 2

6. Trade: Furthermore, if after specialization, each nation 200 bushels of wheat for 200 yards of cloth – Terms of Trade: 1 bushel for 1 yard Wheat Trade Wheat Production Textile Production Textile Trade U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers  200 bushels   200 yards  World+1600 Mexico  40 +200+160+200  200 0 U.S.+200  200 0 +2000 ProdTradeConsProdTradeCons Wheat (bushels)Textiles (yards) exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage consumers in each nation can have more goods available to enjoy. Question: Would the U. S. have an incentive to agree to these terms of trade?Answer: No Question: Would Mexico have an incentive to agree to these terms of trade?Answer: Yes Mexico captures all the gains from specialization Gains of specialization: 160 bushels of wheat. Suppose we wish to keep textile consumption the same in the U.S. and Mexico

7. Trade: Furthermore, if after specialization, each nation 40 bushels of wheat for 200 yards of cloth – Terms of Trade: 1 bushel for 5 yard Wheat Trade Wheat Production Textile Production Textile Trade U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers  40 bushels   200 yards  World+1600 Mexico  40 +400+200  200 0 U.S.+200  40 +160  200 +2000 ProdTradeConsProdTradeCons Wheat (bushels)Textiles (yards) exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage consumers in each nation can have more goods available to enjoy. Question: Would the U. S. have an incentive to agree to these terms of trade?Answer: Yes Question: Would Mexico have an incentive to agree to these terms of trade?Answer: No U.S. captures all the gains from specialization Gains of specialization: 160 bushels of wheat.

8. Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. Wheat Production Textile Production U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers World+1600 Mexico  40 +200 U.S.+200  200 Prod Wheat (bushels)Textiles (yards) Taking Stock Trade Terms of trade: 1 for 1 - 1 bushel of wheat per 1 yard of textiles. Terms of trade: 1 for 5 - 1 bushel of wheat per 5 yards of textiles.  Mexicans enjoy all the benefits of specialization, Americans none.  Americans enjoy all the benefits of specialization, Mexicans none. U.S. enjoys a comparative advantage in the production of wheat. Mexico enjoys a comparative advantage in the production of textiles. Gains of specialization: 160 bushels of wheat. Question: Why don’t we try terms of trade between 1 for 1 and 1 for 5?

9. Mr. A: “American workers are more productive than their Mexican counterparts; hence, trade with Mexico can only hurt the U. S.” Trade: Furthermore, if after specialization, each nation 100 bushels of wheat for 200 yards of cloth – Terms of Trade: 1 bushel for 2 yards Wheat Trade Wheat Production Textile Production Textile Trade U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers  100 bushels   200 yards  World+1600 Mexico  40 +100+60+200  200 0 U.S.+200  100 +100  200 +2000 ProdTradeConsProdTradeCons Wheat (bushels)Textiles (yards) Question: Would the U. S. have an incentive to agree to these terms of trade?Answer: Yes exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage consumers in each nation can have more goods available to enjoy. Question: Would Mexico have an incentive to agree to these terms of trade?Answer: Yes The gains from specialization are shared Gains of specialization: 160 bushels of wheat.

10. Theory of Comparative Advantage: Specialization and Trade Specialization: If each nation specializes in (produces more of) the good in which it enjoys a comparative advantage, the production of goods in the world as a whole can increase. Why Is Free Trade Controversial? Terms of Trade: Trade: Furthermore, if after specialization, each nation exports the good in which it enjoys a comparative advantage and imports the good in which it suffers a comparative disadvantage consumers in each nation can have more goods available to enjoy. Terms of trade: 1 for 1 - 1 bushel of wheat per 1 yard of textiles. Terms of trade: 1 for 5 - 1 bushel of wheat per 5 yards of textiles.  Mexicans enjoy all the gains of specialization.  Americans enjoy all the gains of specialization. Mexico would like terms of trade close to 1 for 1 U.S. would like terms of trade close to 1 for 5 Two reasons.

11. Overall the citizens are better off, but the benefits are not shared equally: Export industries are helped. Import industries are hurt. Sen. Frank Murkowski (R. Alaska) complained that the glut of foreign oil has pushed down oil prices and cost jobs in the energy industry. … Most vehement was Democrat Sen. John D. “Jay” Rockefeller IV (D. W.Va.) who condemned what he called an illegal flood of cheap steel from Japan, Russia, Brazil and elsewhere.” Wheat Production Textile Production U.S. produces 200 more bushels U.S. produces 200 fewer yards 1  worker Mexico produces 40 fewer bushels Mexico produces 200 more yards 2  workers  Benefits American wheat farmers and American farm workers.  Hurts American textile firms and American textile workers.