Principles of Macroeconomics
SAYRE // MORRIS
Tenth Edition
CHAPTER 10
International Trade
Prepared by Hanika Bhojwani-Chen, Centennial College
© 2021 McGraw Hill
13-1
CHAPTER 10
International Trade
Learning Objectives:
1. Explain the importance of international trade and why
nations trade with each other
2. Explain why nations import certain goods, even though they
can be made more cheaply at home
3. Explain how the gains from trade are divided between
trading partners
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CHAPTER 10
International Trade
4. Describe why some groups win and others lose as a result of
freer trade
5. Identify various restrictions to, and some arguments against,
free trade
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LO1: Specialization and
Trade
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Trends in World Trade and GDP
1970-2018
Source: World Trade Organization, International Trade Statistics 2019.
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The World’s Leading Trading Nations
Source: World Trade Organization, Statistical Review, 2019.
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Trade
• Factor endowment
– An advantage in production comes from better
skills, equipment, or other resources
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Factor endowment
• Differences in trade patterns are the result of
− differences in climate
− differences in natural resources
− differences in human capital
− government policies
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Theory of Absolute Advantage
• Theory of absolute advantage
– Nations, like firms and individuals, should specialize in
producing goods and services for which they have an
advantage
– They should trade for goods and services for which they
do not enjoy an advantage
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Absolute Advantage
The table shows the productivity per worker of producing
wheat and beans in Canada and Mexico.
Canada
Mexico
Wheat
3
or
1
or
Beans
2
4
Canada is more productive at producing wheat
than is Mexico, whereas Mexico is more productive
at producing beans than is Canada
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No Specialization, No Trade
Example Continued: No trade, each country has 16
million population (8 million in each industry)
Canada
Mexico
TOTAL
Wheat
Beans
24 million or
16 million
8 million
or
32 million
32 million or 48 million
Each country produces for its domestic use as there
is no trade.
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With Specialization and Trade
Example Continued: With trade, each country has 16
million population (8 million in each industry)
Canada
Mexico
TOTAL
Wheat
48 million or
0 million
or
48 million or
Beans
0 million
64 million
64 million
With specialization, the two countries combined could
produce an additional 16 million bushels of wheat (48
minus the previous 32) and an additional16 million bushels
of beans (64 minus the previous 48). These are referred to
as the gains from trade.
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Specialization and Trade
• Specialization and trade go hand in hand:
– Specialization leads to increased total production
– But if a country is going to specialize, it will need
to trade in order to obtain those products it is not
producing.
– Specialization, then, implies trade, and it would
be impossible to have one without the other.
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Test Your Understanding
The table below shows the productivity per worker in the
beer and wine industries of Freedonia and Libraland:
Freedonia
Libraland
Beer
4
3
Wine
1
4
• Which country should specialize in which product?
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Test Your Understanding
The table shows the productivity per worker in the beer and
wine industries of Freedonia and Libraland:
Freedonia
Libraland
Beer
4
3
Wine
1
4
• Which country should specialize in which product?
Freedonia should specialize in beer and Libraland should
specialize in wine
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Test Your Understanding
Freedonia
Libraland
Beer
4
3
Wine
1
4
• Suppose that initially the working population of each
country is 20 million, with 10 million working in each
industry. What is the total output of the two countries?
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Test Your Understanding
Freedonia
Libraland
Beer
4
3
Wine
1
4
• Suppose that initially the working population of each
country is 20 million, with 10 million working in each
industry. What is the total output of the two countries?
Freedonia
Beer
40 million
Wine
10 million
Libraland
30 million
40 million
Totals
70 million
50 million
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Test Your Understanding
Freedonia
Libraland
Beer
4
3
Wine
1
4
Suppose that each country decides to specialize in the
product in which it has an advantage. What will be the total
output of each product, and what are the gains from trade?
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Test Your Understanding
Freedonia
Libraland
Beer
4
3
Wine
1
4
Suppose that each country decides to specialize in the
product in which it has an advantage. What will be the total
output of each product, and what are the gains from trade?
Freedonia
Beer
80 million
Wine
0
Libraland
0
80 million
80 million
80 million
Totals
Gains are 10 beer, 30 wine
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LO2: Theory of Comparative
Advantage
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Specialization and Trade
• Theory of Comparative Advantage
– The advantage that comes from producing something at a
lower opportunity cost than others are able to do
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Comparative Advantage
Output per Worker by Country and Industry
Number of Bushels per Day
Wheat
Beans
United States
4
or
4
Philippines
1
or
3
• Each country has a trade-off (opportunity cost) for each
item it produces
Opportunity costs of Production
Cost of Producing One Unit
Wheat
Beans
United States
1 bean
or
1 wheat
Philippines
3 beans
or
1/3 wheat
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Comparative Advantage
• The U.S. is comparatively better at making wheat
– It gives up 1 beans, while Philippines gives up 3
Opportunity costs of Production
Cost of Producing One Unit
Wheat
Beans
United States
1 bean
or
1 wheat
Philippines
3 beans
or
1/3 wheat
• The Philippines is comparatively better at beans
– It gives up 1/3 of wheat, while the U.S. gives up 1
– Both can be better off specializing, with trade
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Production Without Trade
• Suppose the United States produces at C, while the
Philippines produces at B (no trade)
Production Possibilities
United States: Output (millions of bushels per day)
A
B
C
D
E
Wheat
400
320
240
160
80
Beans
0
80
160
240
320
Philippines: Output (millions of bushels per day)
A
B
C
D
E
Wheat
100
80
60
40
20
Beans
0
60
120
180
240
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F
0
400
F
0
300
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Production Without Trade
• Suppose the United States produces at C, while the
Philippines produces at B (no trade)
Production Possibilities
United States: Output (millions of bushels per day)
A
B
C
D
E
240
=
Wheat
400 + 80320
240
160
80
Beans
0 Wheat
80
160
240
320
320
Philippines: Output (millions of bushels per day)
A
B
C
D
E
Wheat
100
80
60
40
160 + 6020=
Beans
0
60
120
180
240
220 Beans
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F
0
400
F
0
300
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Specialization With Trade
• Suppose the United States specializes at A, while the
Philippines specializes at F, and they trade
Production Possibilities
United States: Output (millions of bushels per day)
A
B
C
D
E
Wheat
400
320
240
160
80
Beans
0
80
160
240
320
Philippines: Output (millions of bushels per day)
A
B
C
D
E
Wheat
100
80
60
40
20
Beans
0
60
120
180
240
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F
0
400
F
0
300
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Specialization With Trade
• Suppose the United States specializes at A, while the
Philippines specializes at F, and they trade
Production Possibilities
United
States:
Output (millions of bushels per day)
400
Wheat
A
B
C
D
E
Wheat
400
320
240
160
80
Beans
0
80
160
240
320
Philippines: Output (millions of bushels per day)
A
B
C
D
E
Wheat80 more
100Wheat80and
60
40
20
300
Beans 80 more
0 Beans,
60total 120
180 Beans
240
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F
0
400
F
0
300
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LO3: Terms of Trade
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Terms of Trade
• The average price of a country’s exports compared with
the price of its imports
Terms of trade = Average price of exports × 100
Average price of imports
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Terms of Trade
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No Trade Scenario
Output per Worker by Country and Industry
Philippines
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed
Before Trade
60
0
60
80
0
80
After Trade
United States
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed
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Before Trade
160
0
160
240
0
240
After Trade
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With Specialization and Trade
Output per Worker by Country and Industry
Philippines
Beans produced
Beans exported
Beans consumed
Wheat produced
Wheat imported
Wheat consumed
Before Trade
After Trade
60
300
0
-240
60
60
80
0
0
120
80
120
Gain = 40 Wheat
United States
Beans consumed
Wheat consumed
Before Trade
After Trade
Beans produced
160
0
Beans exported
0
240
160
240
Wheat produced
240
400
Wheat imported
0
-120
240
280
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Gain = 80 Beans and 40 Wheat
U.S. Production and Trading Possibilities
Curves
• The slope before trade is 1 (1 wheat for 1 beans)
• If the terms of trade are 2 beans for 1 wheat, the
maximum
quantity of
beans
available
to the U.S.
increases
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Philippines Production and Trading
Possibilities Curves
• The slope before trade is 1/3 (1 wheat for 3 beans)
• If the terms of trade are 2 beans for 1 wheat, the
maximum
quantity of
wheat
available
to the
Philippines
increases
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Test Your Understanding
Output/worker
Freedonia
Libraland
Apples
6
3
Pears
3
2
– Assuming the two countries above wish to trade, would
terms of trade of 1 bushel of pears = 2.5 bushels of apples
be feasible?
– What about 1 bushel of pears = 1 bushel of apples?
– 1 bushel of pears = 1.75 bushels of apples?
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Test Your Understanding
Output/worker
Freedonia
Libraland
Apples
6
3
Pears
3
2
– Assuming the two countries above wish to trade, would
terms of trade of 1 bushel of pears = 2.5 bushels of apples
be feasible?
– What about 1 bushel of pears = 1 bushel of apples?
– 1 bushel of pears = 1.75 bushels of apples?
Only the last one is feasible. In Freedonia, 1 pear costs 2
apples. In Libraland 1 pear costs 1.5 apples. Therefore, the
terms of trade must be between 1 pear = 1.5 to 2 apples.
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Advantages of Free Trade
• Lower prices as the result of lower costs of
production
• Higher incomes
• A greater variety and quality of products
• Increased competition
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LO4: The Effect of Free
Trade
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Demand, Supply and Free Trade
Total Market Demand and Supply of Wine for France and Germany (in millions
of litres per month)
FRANCE
GERMANY
TOTAL MARKET
Price
($/L)
Demand
Supply
Demand
Supply
Demand
Supply
3
19
7
17
2
36
9
4
17
11
15
3
32
14
5
15
15
13
4
28
19
6
13
19
11
5
24
24
7
11
23
9
6
20
29
8
9
27
7
7
16
34
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Demand and Supply
Without Free Trade
• Market for Wine: Demand and supply are higher in France
• Thus in France the quantity is higher and the price is lower
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Demand and Supply
With Free Trade
• Market for Wine: The world price lies between France and
Germany
• France’s surplus (exports) = Germany’s shortage (imports)
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Winners and Losers
from Free Trade
Winners
Losers
Domestic (German) Consumers Foreign (French) Consumers
• More product choices
• Pay higher prices
• Pay lower prices
Foreign (French) Producers
• Bigger market
• Get higher prices
Domestic (German) Producers
• Get lower prices
• More competition
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LO5: Trade Restrictions
and Protectionism
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Trade Protection
• Types:
– Import quotas
– Tariffs
– Currency-exchange controls
– Bureaucratic regulations
– Voluntary export restrictions
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Trade Restrictions
• Quota
– A limit imposed on the production or sale of a product
• Protectionism
– The economic policy of protecting domestic producers by
restricting the importation of foreign products
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Import Quotas
• Import
quotas raise
the price,
lower
imports, and
increase
domestic
production
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Trade Restrictions
• Tariff
– A tax (or duty) levied on imports
• Currency exchange controls
– Government restrictions limiting the amount of foreign
currencies that can be obtained
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Effects of a Tariff
• Tariffs raise the
price, lower
imports,
increase
domestic
production,
and raise tax
revenue
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Trade Restrictions
• Bureaucratic regulations
– Rules that make it hard for foreign products to enter the
country, or require them to be modified before entering
• Voluntary export restriction (VER)
– An agreement by an exporting country to restrict the
amount of its exports to another country
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Arguments Against Free Trade
1. Strategic industry argument
– A country’s strategic industries may be offered protection
so the country does not become dependent on foreign
manufacturers
2. Infant industry argument
– Certain “infant” industries may be protected until they are
sufficiently mature to take on foreign competition
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Arguments Against Free Trade
3. Cultural identity argument
– Free trade brings mass production and standardization,
which may harm the importing country’s sense of identity
4. Environmental and labour standards
– May be eroded to compete with countries whose
standards are lower and have a cost advantage as a result
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Arguments Against Free Trade
5. Argument citing the multiplier effect from domestic
production
6. Uncontrolled movement of capital and labour argument
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CHAPTER 10
Key Concepts to
Remember:
1. Importance of international trade
2. Theories of absolute and comparative advantage
3. Gains from trade stem from differences in the opportunity
costs of production
4. How the gains from trade are divided between trading
partners
5. Why some groups win and others loose as a result of free
trade
6. Trade restrictions and the arguments against free trade
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