Comparative Advantage and the Gains from International Trade

Chapter 8 Comparative Advantage and the Gains from International Trade Prepared by: Fernando & Yvonn Quijano 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. Is Using Trade Policy to Help U.S. Industries a Good Idea? Restrictions on trade may preserve jobs in particular industries, but only at the cost of reducing jobs in other industries. Learning Objectives 8.1 8.2 8.3 8.4 8.5 Discuss the role of international trade in the U.S. economy. Understand the difference between comparative advantage and absolute advantage in international trade. Explain how countries gain from international trade. Analyze the economic effects of government policies that restrict international trade. Evaluate the arguments over trade policy and globalization. APPENDIX Understand why firms operate in more than one country. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 2 of 29 1

The United States in the International Economy Tariff A tax imposed by a government on imports. Imports Goods and services bought domestically but produced in other countries. Exports Goods and services produced domestically but sold to other countries. Learning Objective 8.1 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 3 of 40 The United States in the International Economy The Importance of Trade to the U.S. Economy FIGURE 8-1 International Trade is of Increasing Importance to the United States Learning Objective 8.1 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 4 of 40 2

The United States in the International Economy U.S. International Trade in a World Context FIGURE 8-2 The Eight Leading Exporting Countries Learning Objective 8.1 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 5 of 40 The United States in the International Economy U.S. International Trade in a World Context FIGURE 8-3 International Trade as a Percentage of GDP Learning Objective 8.1 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 6 of 40 3

Comparative Advantage in International Trade A Brief Review of Comparative Advantage Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Opportunity Cost The highest valued alternative that must be given up to engage in an activity. Comparative Advantage in International Trade Table 8-1 An Example of Japanese Workers Being More Productive Than American Workers JAPAN UNITED STATES Learning Objective 8.2 OUTPUT PER HOUR OF WORK CELL PHONES DIGITAL MUSIC PLAYERS 12 6 2 4 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 7 of 40 Comparative Advantage in International Trade Comparative Advantage in International Trade Table 8-2 Absolute advantage The ability to produce more of a good or service than competitors when using the same amount of resources. The Opportunity Costs of Producing Cell Phones and Digital Music Players JAPAN UNITED STATES OPPORTUNITY COSTS CELL PHONES 0.5 digital music player 2 digital music players Learning Objective 8.2 DIGITAL MUSIC PLAYERS 2 cell phones 0.5 cell phone 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 8 of 40 4

How Countries Gain from International Trade Table 8-3 Autarky A situation in which a country does not trade with other countries. Production without Trade JAPAN UNITED STATES PRODUCTION AND CONSUMPTION CELL PHONES 9,000 1,500 Increasing Consumption through Trade Learning Objective 8.3 DIGITAL MUSIC PLAYERS 1,500 1,000 Terms of trade The ratio at which a country can trade its exports for imports from other countries. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 9 of 40 How Countries Gain from International Trade Increasing Consumption through Trade Table 8-4 The Gains from Trade for Japan and the United States WITHOUT TRADE Japan United States WITH TRADE Japan United States GAINS FROM TRADE Japan United States Production and Consumption 0 CELL PHONES 9,000 1,500 CELL PHONES 12,000 4,000 MP3 PLAYERS With trade, the United States and Japan specialize in the good they have a comparative advantage in producing... 0 1,500 1,000 Production with Trade MP3 PLAYERS Increased Consumption 1,500 Cell Phones 1,500 MP3 Players Trade CELL PHONES Export 1,500 Import 1,500 MP3 PLAYERS Import 1,500 Export 1,500...and export some of that good in exchange for the good the other country has a comparative advantage in producing. The increased consumption made possible by trade represents the gains from trade. Learning Objective 8.3 Consumption with Trade CELL PHONES 10,500 1,500 MP3 PLAYERS 1,500 2,500 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 10 of 40 5

Solved Problem 8-3 The Gains from Trade WITH TRADE PORTUGAL ENGLAND WITHOUT TRADE CLOTH 0 90,000 Portugal England PRODUCTION WITH TRADE WINE 150,000 0 PRODUCTION AND CONSUMPTION CLOTH 18,000 63,000 GAINS FROM TRADE Portugal England CLOTH Import 18,000 Export 18,000 TRADE 9,000 wine 9,000 cloth WINE 123,000 18,000 WINE Export 18,000 Import 18,000 INCREASED CONSUMPTION Learning Objective 8.3 CONSUMPTION WITH TRADE CLOTH 18,000 72,000 WINE 132,000 18,000 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 11 of 40 How Countries Gain from International Trade Why Don t We See Complete Specialization? Not all goods and services are traded internationally. Production of most goods involves increasing opportunity costs. Tastes for products differ. Does Anyone Lose as a Result of International Trade? Don t Let This Happen to YOU! Remember That Trade Creates Both Winners and Losers Learning Objective 8.3 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 12 of 40 6

Free trade Trade between countries that is without government restrictions. Figure 8-4 The U.S. Market for Ethanol under Autarky 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 13 of 40 Figure 8-5 The Effect of Imports on the U.S. Ethanol Market 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 14 of 40 7

Tariffs Figure 8-6 The Effects of a Tariff on Ethanol 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 15 of 40 Quotas and Voluntary Export Restraints Quota A numeric limit imposed by a government on the quantity of a good that can be imported into the country. Voluntary export restraint (VER) An agreement negotiated between two countries that places a numeric limit on the quantity of a good that can be imported by one country from the other country. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 16 of 40 8

Quotas and Voluntary Export Restraints Figure 8-7 The Economic Effect of the U.S. Sugar Quota 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 17 of 40 Measuring the Economic Effect of the Sugar Quota We can use the concepts of consumer surplus, producer surplus, and deadweight loss to measure the economic impact of the sugar quota. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 18 of 40 9

Solved Problem 8-4 Measuring the Economic Effect of a Quota World price of apples U.S. price of apples Quantity supplied by U.S. firms Quantity demanded by U.S. consumers Quantity imported Area of consumer surplus Area of domestic producer surplus Area of deadweight loss WITHOUT QUOTA $10 $10 6 million boxes 16 million boxes 10 millions boxes A+B+C+D+E+F G No deadweight loss WITH QUOTA $10 $12 10 million boxes 14 million boxes 4 million boxes A+B G+C D+F 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 19 of 40 The High Cost of Preserving Jobs with Tariffs and Quotas Table 8-5 Preserving U.S. Jobs with Tariffs and Quotas Is Expensive PRODUCT Benzenoid chemicals Luggage Softwood lumber Dairy products Frozen orange juice Ball bearings Machine tools Women's handbags Canned tuna NUMBER OF JOBS SAVED 216 226 605 2,378 609 146 1,556 773 390 COST TO CONSUMERS PER YEAR FOR EACH JOB SAVED $1,376,435 1,285,078 1,044,271 685,323 635,103 603,368 479,452 263,535 257,640 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 20 of 40 10

The High Cost of Preserving Jobs with Tariffs and Quotas Table 8-6 Preserving Japanese Jobs with Tariffs and Quotas Is Also Expensive PRODUCT Rice Natural gas Gasoline Paper Beef, pork, and poultry Cosmetics Radio and television sets COST TO CONSUMERS PER YEAR FOR EACH JOB SAVED $51,233,000 27,987,000 6,329,000 3,813,000 1,933,000 1,778,000 915,000 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 21 of 40 Learning Objective 8.5 The Argument over Trade Policies and Globalization World Trade Organization (WTO) An international organization that oversees international trade agreements. Why Do Some People Oppose the World Trade Organization? Globalization The process of countries becoming more open to foreign trade and investment. Anti-Globalization Some people believe that free trade and foreign investment destroy the distinctive cultures of many countries. Many governments have resisted globalization proposals. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 22 of 40 11

Learning Objective 8.5 The Argument over Trade Policies and Globalization Why Do Some People Oppose the World Trade Organization? Old-Fashioned Protectionism Protectionism The use of trade barriers to shield domestic firms from foreign competition. Protectionism is usually justified on the basis of one of the following arguments: Saving jobs. Protecting high wages. Protecting infant industries. Protecting national security. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 23 of 40 Learning Objective 8.5 The Argument over Trade Policies and Globalization Dumping Dumping Selling a product for a price below its cost of production. Positive versus Normative Analysis (Once Again) Positive analysis concerns what is. Normative analysis concerns what ought to be. 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O Brien, 2e. 24 of 40 12