International Trade and Economic Principles
Chapter Overview
This chapter discusses the concept of international trade, its benefits, and various elements associated with it. It covers the following topics:
17.1: The Gains from Trade
Definition of absolute and comparative advantage
Conditions for mutual benefit from trade
Impact of terms of trade on specialization
The concept of opportunity cost in production
Effects of trade on production and consumption
17.2: Two-Way Trade
Differentiate between one-way and two-way trade
Reasons for the existence of two-way trade
17.3: Restrictions on International Trade
Definition and impact of protectionist policies
Forms of protectionism (tariffs, quotas, etc.)
Justifications for trade restrictions
17.4: Review and Practice
Summary of key points from the chapter including trade, its effects, and implications.
17.1: The Gains from Trade
17.1.1 Key Concepts
Absolute vs. Comparative Advantage:
Absolute Advantage: A country has an absolute advantage in producing a good if it can produce more of that good than another country using the same amount of resources.
Comparative Advantage: A country has a comparative advantage if it can produce a good at a lower opportunity cost than another country.
Mutual Benefits of Trade:
Countries can benefit from trade when they specialize in goods where they hold a comparative advantage.
Terms of Trade:
The terms of trade determine how much of one good must be given up to obtain another good in trade. It affects how countries specialize in production based on their opportunity costs.
Production and Consumption Without International Trade
Hypothetical Scenario: The Country Named Roadway
Roadway operates in isolation with two goods: trucks and boats.
Production Possibilities Curve (PPC): Illustrates the maximum combinations of two goods that can be produced.
If Roadway produces at point D within the curve, it is inefficient. Points A, B, C on the curve are efficient (e.g., producing 3,000 more trucks and 3,000 more boats can be achieved if moving from D to B).
Point E is unattainable; production cannot exceed the PPC.
Opportunity Cost in Production
The slope of the PPC indicates the opportunity cost of increasing the production of one good over the other. As shown in Figure 17.1, the opportunity cost of producing an additional unit of boats, for example, is defined by the slope of the tangent line at any point.
Law of Increasing Opportunity Cost: As production increases, the opportunity cost of producing additional units of a good increases because resources are not perfectly adaptable to the production of both goods.
17.1.2 Comparative Advantage
Example with Two Countries (Roadway and Seaside):
Assume Roadway can produce 10,000 trucks or 10,000 boats, while Seaside can produce 5,000 trucks or 7,000 boats.
Graph comparison shows opportunity costs at points A and A′.
Calculating Opportunity Costs:
In Roadway, the opportunity cost of producing one boat is two trucks, while in Seaside, it’s 0.2 trucks. Hence, Seaside has a comparative advantage in producing boats and Roadway in producing trucks.
Specialization and the Gains from Trade
Trade Opens Up: If Roadway exports trucks and Seaside exports boats, trade allows both countries to consume more than they could if they operated independently.
Terms of Trade: Once trade starts, the exchange ratio will settle between the two countries' opportunity costs which incentivizes a greater focus on comparative advantages and allows for increased efficiencies and productivity.
Exchanging rates (example from Roadway to Seaside):
Before Trade: 1 truck = 0.5 boats (Roadway) vs. 1 truck = 5 boats (Seaside)
After Trade: Potential for greater specialization in each country based on their comparative advantages.
17.1.3 Gains from Trade Illustrated
Graphical Representation (Figure 17.5):
Shows shifts along PPC curves for both countries post-trade, where Roadway focuses on producing 7,000 trucks, while Seaside focuses on 6,000 boats.
Mutual Consumption Benefits: After trading, each country ends up consuming more of both goods than it could have on its own.
Example Figures: Roadway produces more trucks and less boats leading to gains of 500 more trucks and 500 more boats through trade outcomes.
17.1.4 Key Takeaways
Countries can achieve higher total outputs and consumption through specialization based on comparative advantages.
Trade enables economies to consume beyond their domestic production possibilities, while also allowing labor and resources to adjust and specialize efficiently.
17.2: Two-Way Trade
17.2.1 Definition of Two-Way Trade
One-Way vs. Two-Way Trade:
One-Way Trade: Occurs when countries export and import different goods (based on comparative advantages).
Two-Way Trade: Involves countries importing and exporting the same or similar goods (e.g., U.S. importing and exporting cars to/from Japan).
Reasons for Two-Way Trade:
Variations in transportation costs and seasonal effects can lead to two-way trade. Example: One country may find importing certain goods cheaper than domestic production, despite both pulling from similar goods.
Product differentiation: In markets characterized by imperfect competition, consumers may prefer different varieties which creates demand for simultaneous exports and imports.
17.2.2 Benefits of Two-Way Trade
Provides an effective way for economies with similar resource endowments to engage efficiently without drastically reallocating resources in and out of industries, resulting in lower adjustment costs.
17.3: Restrictions on International Trade
17.3.1 Protectionist Policies Defined
Protectionism: Policies to restrict imports with means of supporting domestic industries;
Examples include tariffs, quotas, and non-tariff barriers.
Aim to increase domestic product prices and protect local jobs.
17.3.2 Forms of Protectionism
Tariffs: Taxes on imports that raise foreign product prices in the domestic market, leading to less consumption of foreign goods.
Quotas: Limits on the quantity of a good that can be imported which further raise domestic prices.
Antidumping Measures: Measures taken against foreign firms selling below their cost to protect domestic producers.
Voluntary Export Restrictions: Agreements by foreign producers to limit exports, often brought about under pressure from the importing country's government.
Other Non-Tariff Barriers: Include quality standards and safety regulations that complicate imports without explicit tariffs.
Economic Effects
Protectionist policies generally lead to increased prices and reduced availability of targeted goods, impacting consumers negatively.
17.3.3 Justifications for Trade Restrictions
Infant Industry Argument: New domestic industries may need protection to become competitive globally.
Strategic Trade Policy: Supporting emerging industries for potential oligopoly dominance might justify temporary trade barriers.
National Security: Protecting critical industries to maintain self-sufficiency during crises.
Job Protection: Protecting existing jobs from cheaper imports; however, maintaining jobs in declining industries can be costly and ineffective in the long run.
Protecting Against Cheap Labor: Safeguarding against labor exploitation abroad and ensuring fair competition.
Environmental Standards: Differences between countries might justify protective measures.
17.4: Review and Practice
Key Ideas Summarized
Production Possibilities Curve: Understanding trade allows nations to consume beyond their PPCs, leading to global increases in efficiency and specialization.
Two-Way Trade: A common scenario in high-income countries characterized by goods imported and exported simultaneously.
Trade Barriers: Various forms can reduce overall market efficiency while addressing specific domestic concerns.
Concept Problems
Discuss implications of free trade, job displacement, and potential for mutual gains beyond productively feasible limits through trade.
Numerical Problems
Emphasize the role of comparative advantage in determining trade benefits and establish numerical trade scenarios demonstrating mutual gains.