International Trade

Comparative Advantage and International Trade

  • Definition: Comparative advantage indicates that a party should produce goods where they have a relative efficiency or lower opportunity cost compared to others.

  • Principles:

    • Produce what you are relatively good at.

    • Complete tasks at a lower opportunity cost than someone else.

    • Buy what you are relatively bad at.

  • Result:

    • Mutual benefits arise from trade; both parties can produce more together than apart.

Sources of Comparative Advantage

  • Abundant Inputs: Factors that contribute to a country's comparative advantage include:

    • Geography: Location advantages can influence production capabilities.

    • Resources: Availability of natural resources and raw materials.

    • Climate: Climatic conditions may affect agricultural and production efficiency.

    • People: Workforce demographics and characteristics (skills, education, etc.)

  • Specialized Skills: Expertise or specific capabilities in producing certain goods.

  • Specialized Production Lines: Efficiency achieved through focused production methods.

Trade Costs: Is International Trade Worth It?

  • Importing Goods: Conditions under which importing a product is advantageous:

    • Condition: Foreign price + trade costs < domestic price

    • This entails that the price offered by foreign suppliers, even after accounting for trade-related costs, should be lower.

  • Exporting Goods: Conditions under which exporting is beneficial:

    • Condition: Foreign price - trade costs > domestic price

    • The foreign market must provide a higher price for goods compared to domestic markets when factoring in costs of export.

Understanding Trade Costs

  • Definition: Trade costs are the additional expenses related to international transactions as opposed to domestic transactions.

  • Examples of Trade Costs:

    • Shipping costs and potential delivery delays

    • Taxes levied by the U.S. government on imports

    • Taxes imposed by foreign governments on exports

    • Complications related to language barriers

    • Issues arising from different time zones

    • Legal and regulatory compliance across borders

FRED Globalization

  • Gross Domestic Product Shares:

    • Imports of Goods and Services:

    • Q2 2025 projection: 13.7%

    • Exports of Goods and Services:

    • Q2 2025 projection: -3.0%

    • Net Exports: Calculated based on the difference between imports and exports.

    • Trends over the Years: Graph indicates changes in imports, exports, and overall economic indicators from 1950 to 2025.

    • Recessions: Shaded sections of the graph indicate periods of recession in the U.S. economy.

The Domestic Market (No International Trade)

  • Demand Curve: Represents the quantity of goods that domestic buyers (all American consumers) are willing to purchase at various price levels.

  • Supply Curve: Represents the quantity of goods that domestic producers (all sellers in America) are prepared to supply at different price levels.

  • No-Trade Equilibrium:

    • Definition: The market state where the quantity demanded equals the quantity supplied domestically.

    • Example:

    • Quantity of shirts (millions per year): 100

    • Price of shirts: $20

How Imports Change Your Market

  • Scenario: World price of shirts set at $12.

Step 1: New Price Determination

  • Equilibrium Price: Buyers are willing to pay no more than $12, identical to sellers' lowest acceptable price.

  • Result: Price of imported shirts drops to the world price of $12.

Step 2: Quantity Demanded and Supplied at New Price

  • At $12:

    • Quantity supplied by domestic sellers drops to 40 million shirts.

    • Quantity demanded by domestic buyers rises to 140 million shirts.

  • Big Picture Result: Increased consumer demand and decreased producer supply.

Step 3: Imports Assessment

  • Quantity Traded:

    • Imports fulfill the gap between demand and supply.

    • Calculation: 140 million (demand) - 40 million (supply) = 100 million shirts imported.

Imports Raise Economic Surplus

1. No Trade Scenario

  • Visual representation of consumer and producer surplus in a no-trade scenario.

2. Free-Trade Scenario

  • Consumer Surplus: Increases for domestic buyers due to access to lower-priced imports.

  • Producer Surplus: Declines for domestic sellers owing to foreign competition.

3. Surplus Redistribution

  • Economic surplus increases overall but benefits transfer from producers to consumers.

  • Outcome: Overall economic surplus grows, but the distribution of wealth shifts.

How Exports Change Your Market

  • Scenario: World price of snowmobiles set at $12,000.

Step 1: New Price Determination

  • Equilibrium Price: Sellers maintain a price of $12,000, corresponding to their minimum acceptable price and buyers’ maximum willingness to pay.

Step 2: Quantity Demanded and Supplied at New Price

  • At $12,000:

    • Quantity supplied by domestic sellers increases to 70,000 snowmobiles.

    • Quantity demanded by domestic buyers declines to 40,000 snowmobiles.

Step 3: Quantitative Evaluation of Trade

  • Quantity Traded: 30 thousand snowmobiles are exported as the difference between supply and demand.

Exports Raise Economic Surplus

1. No Trade Scenario

  • Analyzes consumer surplus and producer surplus without trade.

2. Free-Trade Scenario Outcomes

  • Consumer Surplus: Decreases due to increased competition from foreign markets.

  • Producer Surplus: Gains from selling at higher prices in international markets.

3. Redistribution Impact

  • Exports shift surplus from consumers to producers, enhancing overall economic surplus but not uniformly across all stakeholders.

Summarizing the Consequences of Trade

  • Effects of Imports:

    • Domestic price adjusts to the world price, impacting quantities demanded and supplied.

    • Consumer surplus experiences a significant gain.

    • Producer surplus incurs a slight fall.

  • Effects of Exports:

    • Domestic price aligns with world prices, affecting local demand and supply.

    • Minor decline in consumer surplus.

    • Substantial gain in producer surplus.

  • Overall Economic Surplus:

    • Trade poses complexities regarding benefits; some parties win while others lose.

Understanding the Tools of Trade Policy

  • Role of Business Managers:

    • Compete effectively in international markets while navigating political and legal landscapes.

  • Assessing Trade Policies:

    • Evaluating the impact of tariffs is essential for strategic management.

    • Tariff Definition: A tax levied on imported goods to increase trade costs.

The Effect of an Import Tariff

1. Initial Pre-Tariff Situation

  • Review consequences of free trade without tariffs and determine potential impacts of a $4 tariff on T-shirts.

2. Step 1: New Price Calculation

  • Without Tariff Scenario:

    • Price: $12; quantity supplied: 40 million; quantity demanded: 140 million.

  • With Tariff:

    • New price = World price ($12) + Tariff ($4) = $16.

3. Step 2: Demand and Supply Reaction at New Price

  • Outcomes at $16:

    • Lower buyer demand and increased seller supply.

4. Step 3: Quantity Trading Assessment

  • Tariff-induced affected imports result in reduced quantity traded.

  • Government Revenue:

    • Revenue = quantity imported × tariff amount ($4).

5. Tariff Impact on Surplus

  • Consumer surplus contracts significantly.

  • Producer surplus expands slightly.

  • Government collects portion of consumer surplus as revenue.

  • Overall Economic Surplus:

    • Economic surplus diminishes as a result.