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International Trade,Comparative Advantage,and Protectionism
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Chapter Outline
International Trade,Comparative Advantage,
and Protectionism Trade Surpluses and Deficits
The Economic Basis for Trade:
Comparative Advantage Absolute Advantage versusComparative Advantage
Terms of TradeExchange Rates
The Sources of Comparative Advantage
The Heckscher-Ohlin TheoremOther Explanations for Observed
Trade Flows
Trade Barriers: Tariffs, ExportSubsidies, and Quotas
Free Trade or Protection?The Case for Free TradeThe Case for Protection
An Economic Consensus
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TRADE SURPLUSES AND DEFICITS
TABLE 20.1 U.S. Balance of Trade (Exports Minus Imports), 1929±2004
(Billions of Dollars)
EXPORTS MINUS IMPORTS EXPORTS MINUS IMPORTS
1929 + 0.4 1986 ± 132.7
1933 + 0.1 1987 ± 148.2
1945 ± 0.8 1988 ± 110.4
1955 + 0.5 1989 ± 88.2
1960 + 4.2 1990 ± 78.0
1965 + 5.6 1991 ± 27.5
1970 + 4.0 1992 ± 33.2
1975 + 16.0 1993 ± 65.0
1976 ± 1.6 1994 ± 93.6
1977 ± 23.1 1995 ± 91.4
1978 ± 25.4 1996 ± 96.2
1979 ± 22.5 1997 ± 101.6
1980 ± 13.1 1998 ± 159.9
1981 ± 12.5 1999 ± 260.5
1982 ± 20.0 2000 ± 379.5
1983 ± 51.7 2001 ± 367.0
1984 ± 102.7 2002 ± 424.4
1985 ± 115.2 2003 ± 500.9
2004 ± 624.4Source: U.S. Department of Commerce, Bureau of Economic Analysis.
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
Corn Laws The tariffs, subsidies, and restrictionsenacted by the British Parliament in the earlynineteenth century to discourage imports and
encourage exports of grain.
theory of comparative advantage Ricardo¶s theory thatspecialization and free trade will benefit all tradingpartners (real wages will rise), even those that may be
absolutely less efficient producers.
Specialization and free trade will benefit all trading partners (real wages will rise), even those
that may be absolutely less efficient producers.
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
absolute advantage The advantage in the productionof a product enjoyed by one country over another when
it uses fewer resources to produce that product than the other country does.
comparative advantage The advantage in the
production of a product enjoyed by onecountry over another when that product can beproduced at lower cost in terms of other goods than itcould be in the other country.
ABSOLUTE ADVANTAGE VERSUS COMPARATIVE ADVANTAGE
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
Gains from Mutual Absolute AdvantageTABLE 20.2 Yield Per Acre of Wheat and Cotton
NEW ZEALAND AUSTRALIA
Wheat 6 bushels 2 bushels
Cotton 2 bales 6 bales
TABLE 20.3 Total Production of Wheat and Cotton Assuming No Trade, Mutual Absolute Advantage, and100 Available Acres
NEW ZEALAND AUSTRALIA
Wheat 25 acres x 6 bushels/acre150 bushels
75 acres x 2 bushels/acre150 bushels
Cotton 75 acres x 2 bales/acre150 bales
25 acres x 6 bales/acre150 bales
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
FIGURE 20.1 Production Possibility Frontiers for Australia and New Zealand before Trade
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
TABLE 20.4 Production and Consumption of Wheat and Cotton after Specialization
PRODUCTION CONSUMPTION
New Zealand Australia New Zealand Australia
Wheat 100 acres x 6 bushels/acre600 bushels
0 acres0
300 bushels 300 bushels
Cotton 0 acres0
100 acres x 6 bales/acre600 bales
300 bales 300 bales
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
FIGURE 20.2 Expanded Possibilities after Trade
Trade enables both countries to move beyond their previous resource and productivity
constraints.
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
TABLE 20.5 Yield Per Acre of Wheat and Cotton
NEW ZEALAND AUSTRALIA
Wheat 6 bushels 1 bushel
Cotton 6 bales 3 bales
Gains from Comparative Advantage
TABLE 20.6 Total Production of Wheat and Cotton Assuming No Trade and 100 Available Acres
NEW ZEALAND AUSTRALIA
Wheat50 acres x 6 bushels/acre
300 bushels75 acres x 1 bushels/acre
75 bushels
Cotton 50 acres x 6 bales/acre300 bales
25 acres x 3 bales/acre75 bales
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
TABLE 20.7 Realizing a Gain from Trade When One Country Has a Double Absolute AdvantageSTAGE 1 STAGE 2
New Zealand Australia New Zealand Australia
Wheat
50 acres x 6 bushels/acre300 bushels
0 acres0
75 acres x 6 bushels/acre450 bushels
0 acres0
Cotton 50 acres x 6 bales/acre300 bales 100 acres x 3 bales/acre300 bales 25 acres x 6 bales/acre150 bales 100 acres x 3 bales/acre300 bales
STAGE 3
New Zealand Australia
100 bushels (trade)
Wheat 350 bushels 100 bushels
(after trade)
200 bales (trade)
Cotton 350 bales 100 bales
(after trade)
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
Why Does Ricardo¶s Plan Work?
When countries specialize in producing goods in which they have a comparative advantage,
they maximize their combined output and allocate their resources more efficiently.
FIGURE 20.3 Comparative Advantage Means Lower Opportunity Cost
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
TERMS OF TRADE
terms of trade The ratio at which a country can tradedomestic products for importedproducts.
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
EXCHANGE RATES
exchange rate The ratio at which two currencies aretraded. The price of one currency in terms of another.
When trade is free²unimpeded by government-instituted barriers²patterns of trade and
trade flows result from the independent decisions of thousands of importers and exporters
and millions of private households and firms.
First, for any pair of countries, there is a range of exchange rates that can lead automatically
to both countries¶ realizing the gains from specialization and comparative advantage.
Second, within that range, the exchange rate will determine which country gains the most
from trade. In short, exchange rates determine the terms of trade.
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THE ECONOMIC BASIS FOR TRADE:COMPARATIVE ADVANTAGE
Trade and Exchange Rates in a Two-Country/Two-GoodWorld
TABLE 20.8 Domestic Prices of Timber (Per Foot) and Rolled Steel (Per Meter) in theUnited States and Brazil
UNITED STATES BRAZIL
Timber $1 3 Reals
Rolled steel $2 4 Reals
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THE SOURCES OF COMPARATIVE ADVANTAGE
factor endowments The quantity and quality of labor,land, and natural resources of a country.
THE HECKSCHER-OHLIN THEOREM
Heckscher-Ohlin theorem A theory thatexplains the existence of a country¶s comparativeadvantage by its factor endowments: A country has acomparative advantage in the production of a product if that
country is relatively well endowed with inputs usedintensively in the production of that product.
A country has a comparative advantage in the production of a product if that country is
relatively well endowed with inputs used intensively in the production of that product.
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OTHER EXPLANATIONS FOR OBSERVEDTRADE FLOWS
Some theories argue that comparative advantage can beacquired. Just as industries within a country differentiate their products to capture a domestic market, so too do theydifferentiate their products to please the wide variety of tastesthat exists worldwide. This theory is consistent with the theory of comparative advantage.
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TRADE BARRIERS: TARIFFS, EXPORT SUBSIDIES, ANDQUOTAS
protection The practice of shielding a sector of theeconomy from foreign competition.
tariff A tax on imports.
export subsidies Government payments made todomestic firms to encourage exports.
dumping A firm or industry¶s sale of products on the
world market at prices below the cost of production.
quota A limit on the quantity of imports.
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TRADE BARRIERS: TARIFFS, EXPORT SUBSIDIES, ANDQUOTAS
Smoot-Hawley tariff The U.S. tariff law of the 1930s,which set the highest tariffs inU.S. history (60 percent). It set off an international
trade war and caused the decline in trade that is oftenconsidered a cause of the worldwide depression of the1930s.
U.S. Trade Policies and GATT
General Agreement on Tariffs and Trade (GATT) Aninternational agreementsigned by the United States and 22 other countries in1947 to promote the liberalization of foreign trade.
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TRADE BARRIERS: TARIFFS, EXPORT SUBSIDIES, ANDQUOTAS
economic integration Occurs when two or morenations join to form a free-trade zone.
Economic Integration
European Union (EU) The European trading bloccomposed of Austria, Belgium, Denmark, Finland,France, Germany,Greece, Ireland, Italy, Luxembourg, the Netherlands,Portugal, Spain, Sweden, and the United Kingdom.
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TRADE BARRIERS: TARIFFS, EXPORT SUBSIDIES, ANDQUOTAS
U.S.-Canadian Free Trade Agreement Anagreement in which the United States and Canadaagreed to eliminate all barriers to trade between the
two countries by 1998.
North American Free Trade Agreement(NAFTA) An agreement signed by the United States,Mexico, and Canada in which the three countriesagreed to establish allNorth America as a free-trade zone.
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FREE TRADE OR PROTECTION?
THE CASE FOR FREE TRADE
Trade barriers prevent a nation from reaping the benefits of specialization, push it to adopt
relatively inefficient production techniques, and force consumers to pay higher prices for
protected products than they would otherwise pay.
FIGURE 20.4 The Gains from Trade and Losses from the Imposition of a Tariff
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FREE TRADE OR PROTECTION?
THE CASE FOR PROTECTIONProtection Saves Jobs
Some Countries Engage in Unfair Trade Practices
Cheap Foreign Labor Makes Competition Unfair
Protection Safeguards National Security
Protection Discourages Dependency
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FREE TRADE OR PROTECTION?
Protection Safeguards Infant Industries
infant industry A young industry that may needtemporary protection from competition from the
established industries of other countries to developan acquired comparative advantage.
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absolute advantage
comparative advantage
Corn Laws
dumping
economic integrationEuropean Union (EU)
exchange rate
export subsidies
factor endowments
General Agreement on Tariffs and
Trade (GATT)
Heckscher-Ohlin theorem
infant industry
REVIEW TERMS AND CONCEPTS
North American Free Trade Agreement (NAFTA)
protection
quota
Smoot-Hawley tariff tariff
terms of trade
theory of comparative advantage
trade deficit
trade surplus
U.S.-Canadian Free Trade Agreement