CHAPTER 16

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CHAPTER 16
INTERNATIONAL TRADE AND GLOBALIZATION
After reading Chapter 16, INTERNATIONAL TRADE AND GLOBALIZATION, you should be able to:
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Discuss the notions of GLOBALIZATION and DEVELOPING ECONOMY.
Define the LAW OF COMPARATIVE ADVANTAGE and explain why it is the basis of trade.
Discuss the gains from trade and explain why the average person is made better off by international
trade.
Define TARIFF, IMPORT QUOTA and VOLUNTARY EXPORT QUOTA and tell how each
limits trade.
Give protectionist arguments against free trade and present the arguments used by economists to oppose
protectionism.
Describe the history of American trade policies.
CHAPTER OUTLINE
I. GLOBALIZATION and DEVELOPING ECONOMIES.
A. Participation in global markets depends on the ease of communication and the costs of transporting
goods and services long distances. GLOBALIZATION is the degree to which national markets
and international businesses are integrated into a world economy.
B. Per capita GDP is the most comprehensive measure of the level of economic development. Only 15
percent of the world’s population lives in the developed countries of the United States and Western
Europe, Canada, Australia, and Japan. A DEVELOPING COUNTRY is a country with a per
capita income well below that of a typical advanced country.
II. THE LAW OF COMPARATIVE ADVANTAGE AND INTERNATIONAL TRADE
A.
B.
C.
COMPARATIVE ADVANTAGE means employing a resource in its best use.
The LAW OF COMPARATIVE ADVANTAGE states that people or countries gain if they
specialize in activities in which their advantage over others is greatest or in which their
disadvantage is smallest.
1. The law of comparative advantage explains why individuals SPECIALIZE by producing only
a few products.
2. If a person or country is superior to all others in all things, the law of comparative advantage
points out it is best for the person or country to specialize in the one activity in which the
margin of superiority is largest.
Each country tends to produce and export goods in which its resource base gives it a comparative
advantage.
1. America has an abundance of highly skilled labor, so the United States tends to export goods
that require skilled labor and a lot of research and development to produce.
2. Low efficiency nations can compete with high efficiency countries because the workers in the
high efficiency nations receive higher wages than the workers in the low efficiency countries.
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D.
Trade between countries is beneficial because the average citizen in all the countries is made better
off by the trade.
1. The average citizen gains because trade raises his or her income and lowers the prices of
imported goods.
2. Some people lose from the trade while others gain. But, the benefit to the gainers exceeds the
loss to the losers.
III. TRADE BARRIERS
A.
B.
C.
D.
IV.
A.
B.
C.
D.
E.
Trade barriers include tariffs, import quotas, and voluntary export quotas.
1. TARIFFS are taxes levied on imports.
2. IMPORT QUOTAS regulate the amount of a good that can be brought into a country over a
given time period.
3. VOLUNTARY EXPORT QUOTAS are agreements the home government makes with a
foreign government to allow only a limited number of exports from the foreign country into
the home country.
Trade barriers raise the price of the protected goods. Consumers demand fewer imported goods and
the domestic production of import-competing goods rises.
1. When a country restricts its imports, it necessarily lowers its exports. Thus trade barriers lower
output in export industries.
Trade barriers harm the average citizen.
1. They are imposed because the benefits they create are concentrated among a few sectors,
while their costs are widely diffused throughout the society.
A common protectionist argument in favor of trade barriers is that industries need protection from
unfair foreign competitors who pay their workers low wages.
1. Industries with a comparative advantage can compete even with low foreign wages.
2. Industries in which a country does not have a comparative advantage are unable to compete
with foreign firms.
3. If noncompetitive industries are protected, jobs are lost in competitive industries and the
standard of living is lowered.
AMERICAN TRADE POLICIES
Tariffs have fluctuated up and down. They reached their peak in 1930 as a result of the SMOOTHAWLEY ACT.
The Reciprocal Trade Agreement Act of 1934 amended the Smoot-Hawley Act and allowed the
President to lower tariffs when foreign countries agreed to lower their tariffs.
The Trade Expansion Act of 1962 gave the President further powers to lower tariffs.
The Trade Reform Act of 1974 resulted in a further reduction of tariffs.
Since 1932, the average tariff has been lowered from about 59 percent to less than 5 percent.
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REVIEW QUESTIONS
True or False
If the statement is correct, write true in the space provided; if it is wrong, write false. Below the question
give a short statement that supports your answer.
____ 1.
The law of comparative advantage states that a person should do what he or she does best
without regard to the skills of other people.
____ 2.
If people and countries follow the law of comparative advantage, they tend to specialize in the
production of relatively few items.
____ 3.
Everyone in a country directly gains from international trade.
____ 4.
The average person in a country gains from international trade.
____ 5.
A tariff is a quantitative limit on the amount of a good that may be imported into a country
during a given period.
____ 6.
Countries tend to import goods in which they have a comparative advantage.
____ 7.
The United States has a comparative advantage in manufacturing nonstandardized, new
products.
____ 8.
International trade reduces the prices of goods that will be imported into the country.
____ 9.
An import quota is an example of a nontariff trade barrier.
____ 10. When a country specializes in producing the products in which it has a comparative advantage,
the country's income is maximized.
____ 11. Voluntary export quotas have no effect on prices paid by domestic consumers.
____ 12. If a country restricts its imports, it also restricts the amount it can export.
____ 13. In the past 50 years, tariffs have steadily increased.
Multiple Choice
Circle the letter corresponding to the correct answer.
1.
The cost of restricting imports into a country is
a. a loss of jobs in export industries.
b. a fall in the standard of living.
c. a decrease in the number of goods that can be consumed.
d. a fall in average income.
e. all of the above.
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2.
The American government program that raised tariffs to their highest level was the
a. Smoot-Hawley Act.
b. the Reciprocal Trade Agreement.
c. the Trade Expansion Act.
d. the Trade Reform Act.
e. the Tokyo Round.
3.
The law of comparative advantage suggests all of the following except
a. nations and individuals tend to produce only a few items.
b. the United States tends to export new products requiring a lot of research and development.
c. trade barriers harm the people within the nation erecting the barriers.
d. nations will be better off if they protect their industries that have a comparative disadvantage.
e. nations tend to export goods in which they have an abundance of the necessary factors of
production.
For the next 6 questions, use the following table:
Country
A
B
Wheat Produced Using
1 Hour of Labor
3 Bushels
9 Bushels
Books Produced Using
1 Hour of Labor
12 Books
18 Books
4.
Before trade, in Country A, 1 bushel of wheat costs how many books?
a. 1
b. 2
c. 4
d. 12
e. It is impossible to tell from the table.
5.
Before trade, in Country B, 1 bushel of wheat costs how many books?
a. 1
b. 2
c. 4
d. 12
e. It is impossible to tell from the table.
6. Country B has a comparative advantage in the production of
a. wheat.
b. books.
c. neither wheat nor books.
d. both wheat and books.
e. It is impossible to tell from the table.
7.
Country A has a comparative advantage in the production of
a. wheat.
b. books.
c. neither wheat nor books.
d. both wheat and books.
e. It is impossible to tell from the table.
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8.
Before trade, in Country B wheat is ____ compared to Country A, so Country B ____ wheat.
a. inexpensive; exports
b. inexpensive; imports
c. expensive; imports
d. expensive; exports
e. the same price; may import or export
9.
Before trade, in Country A ____ is inexpensive compared to Country B, so Country A exports ____.
a. books; books
b. books; wheat
c. wheat; books
d. wheat; wheat
e. nothing; nothing
Essay Questions
Write a short essay or otherwise answer each question.
1. What is a common argument in favor of protectionist policies? What are the costs of protectionist
policies?
2. Suppose a foreign country was willing to give steel away in the United States. Would you favor a tariff
on imported steel if you were a steelworker? If you were an auto worker? (Manufacturing automobiles
requires a lot of steel.)
For the next 5 questions, use the following table.
Computers Produced Using
1 Hour of Labor
United States
4 Computers
Korea
1 Computer
Shirts Produced Using
1 Hour of Labor
8 Shirts
4 Shirts
3. In the United States, before trade, what is the price of 1 computer in terms of shirts? What is the Korean
price of computers?
4. The United States has a comparative advantage in which good? This good is cheaper in which country?
5. Korea has a comparative advantage in which good? The United States is more efficient than Korea in
producing both goods, since an hour of labor produces more computers and more shirts in the United
States. How is it possible for Korea to have a comparative advantage and export anything to the United
States?
6. What is the after-trade price of computers?
7. Suppose the United States transfers 1 hour of labor from shirts to computers while Korea switches 3
hours of labor from computers to shirts. What is the net effect of these changes on world output of
computers and shirts? Does specialization increase overall production of goods?
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8. The following statement is often made by people in developed countries: "We cannot compete with
foreign producers because their wages are too low. Thus we need to protect our industries." Also, the
following assertion is made by people in less-developed countries: "We cannot compete with foreign
producers because their level of technology is too high. Thus we need to protect our industries."
Evaluate these claims.
ANSWERS TO REVIEW QUESTIONS
True or False
False
1.
The law of comparative advantage states that people should specialize in things in which their
advantage relative to others is greatest.
True
2.
Countries and people specialize in producing only the few things for which they are best
suited. They trade with other (specialist) producers for most of their consumption goods.
False
3.
The people and firms that compete with imported goods can be harmed by trade.
True
4.
Question 3 points out that some people may be harmed by trade. But most people gain from
trade so that, on net, the average person benefits from trade.
False
5.
A tariff is a tax levied on goods imported into a nation; an import quota is a quantitative limit
on the amount that may be imported.
False
6.
Countries export goods in which they have a comparative advantage.
True
7.
Because the United States has a comparative advantage in these goods, we should expect
(correctly) that it exports this type of product.
True
8.
This price reduction is one of the ways the average person gains from trade.
True
9.
Other examples are voluntary export quotas and tariffs.
True
10. This is effectively the reason why free trade according to comparative advantage makes every
nation better off.
False
11. Voluntary export quotas, like all barriers to trade, raise the prices paid by domestic consumers
for imported goods.
True
12. This is part of the cost imposed by protectionist barriers to trade.
False
13. In the past fifty years, tariffs generally have fallen.
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Multiple Choice
1.
e. All of these are costs inflicted on society by protectionist measures that limit the amount of
imports.
2.
a. The Smoot-Hawley tariff was passed in 1930 and may have contributed to worsening the Great
Depression. It has been relaxed with amendments starting in 1934.
3.
d. The law of comparative advantage points out that the country ought to let other nations produce the
goods in which it has a comparative disadvantage and produce only the things in which it has a
comparative advantage.
4.
c. In Country A, to produce 1 bushel of wheat requires 1/3 of an hour. Thus 1 bushel of wheat
requires the sacrifice of 4 books, the number of books produced in 1/3 hour. Therefore, in country
A 1 bushel of wheat costs 4 books.
5.
b. In Country B, to produce 1 bushel of wheat requires 1/9 of an hour so there are 2 books lost to
produce a bushel of wheat. Hence, the price of a bushel of wheat is 2 books in country B.
6.
a. Country B is 3 times more productive in producing wheat than Country A. (In one hour of time, B
produces 9 bushels while A can grow only 3.) Country B is only 1.5 times more efficient than A in
manufacturing books, so B's greatest advantage lies in wheat. Compare this with the answers from
questions 4 and 5, and you can see that this comparative advantage is reflected in a lower pre-trade
price of books in country B.
7.
b. While Country B can produce both goods more efficiently than Country A, A's relative
disadvantage is less in book production. Therefore, A has comparative advantage in producing
books.
8.
a. Questions 4 and 5 demonstrated that in Country A, a bushel of wheat costs 4 books while in
country B a bushel of wheat costs only 2 books. Wheat is cheaper in country B, so B exports wheat
to country A. This is a specific example of the general proposition that before trade the product in
which a country has a comparative advantage is cheap compared to its price in other countries.
9.
a. Before trade, a book in country A costs 1/4 of a bushel of wheat and costs 1/2 a bushel of wheat in
country B. (These prices are calculated analogously to those in Questions 4 and 5.) Hence, books
are cheaper in A and so country A exports books.
Essay Questions
1. The most commonly encountered argument is that it is impossible to compete with foreign nations
because the wages paid to foreign workers are too low. Protectionist policies harm society in a variety of
ways: they raise the cost of imported goods, they lower employment in the export industries, they lower
the nation's real income, and they lower the welfare of the nation.
2. If you were a steelworker, you would favor a tariff to help protect your job. If you were an auto worker,
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you probably would oppose a tariff: If the price of steel in the United States were lower, the price of
American-made cars would be lower, so your job would be more secure. This question points out the
important fact that even though international trade benefits the nation as a whole, it harms some sectors
and some people.
3. In the United States, 1 computer costs 2 shirts: to produce 1 computer reduces the number of shirts by 2.
In Korea, 1 computer costs 4 shirts.
4. The United States has a comparative advantage in computers. It is 4 times more productive in producing
computers and only 2 times more productive in producing shirts. The price of computers is cheaper in
the United States. This reflects the comparative advantage the United States enjoys in computers.
5. Korea has a comparative advantage in producing shirts. Manufacturing shirts minimizes the
disadvantage Korea faces in both products. Korea can export shirts to the United States because the
price of shirts is lower in Korea than in the United States. Before trade, 1 shirt costs only 1/4 computer
in Korea but 1/2 computer in the United States. Since the price of shirts is lower in Korea, Korea can
successfully export them.
6. We do not know what the price of computers is after trade. We do know that the price is less than (or
equal to) 4 shirts and more than (or equal to) 2 shirts. In order to determine the precise post-trade price,
we need more information about demand for the goods in the countries.
7. Computers:
Shirts:
(+4) in the United States plus (-3) in Korea
(-8) in the United States plus (+12) in Korea
= +1 computer.
= +4 shirts.
These results show that specialization corresponding to the law of comparative advantage raises total
world output in all products.
8. These assertions obviously are related, and both are false. Developed countries can compete
successfully with low-wage countries in those industries in which their technological lead gives them a
comparative advantage. Basically, the high technology offsets the high wages in developed countries.
Less-developed countries can compete in those industries in which their low wages offset the
technological lead of advanced countries. Both developed and less-developed countries have industries
with comparative advantages and industries with comparative disadvantages.
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