Free Trade Theory Why Nations Trade. Basics of Trade Defined: 2 Countries engage in economic...
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Free Trade TheoryWhy Nations Trade
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Basics of Trade
• 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
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Why Trade?
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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
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Adam Smith• In his 1776 book Wealth of Nations, Adam Smith
talked about specialization
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When each worker madetheir own pins, they produced 20 pins per day each
Adam Smith on Specialization
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
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Specialization works!
Any illegal activity you can think of…
+
Idaho
Nevada
Texas
Florida
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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
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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
Ricardo’s Trade TheoryHere is my
great theory!
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Practice Problems