McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives
• Comparative advantage and the gains from trade
• Exports and imports
• Economic effects of tariffs and quotas
• Arguments for protectionism
37-2

Some Key Facts
• What is the import/export situation with goods? Services?
• U.S. trade deficit in goods
–$735 billion in 2014
• U.S. trade surplus in services
–$231 billion in 2007
• Canada largest U.S. trade partner
• Trade deficit with China
–$257 billion in 2007 – 2014?
–$342 billion in 2014
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World Exports
Percentage Share of World Exports,
Selected Nations, 2007
Germany
United States
China
Japan
France
Netherlands
United Kingdom
Italy
0 2 4 6 8 10 12
4.06
3.83
5.38
3.71
3.40
9.20
8.59
8.02
2012,
13%
Source: World Trade Organization
37-4

Economic Basis for Trade
• Nations have different resource endowments
• Labor-intensive goods
• Land-intensive goods
• Capital-intensive goods
37-5

Comparative Advantage
• Assumptions
–Two nations
–Same size labor force
–Constant costs in each country
–Different costs across countries
–U.S. absolute advantage in both
• Opportunity cost ratio
–Slope of the curve
–Coffee sacrificed per ton of wheat
37-6

20
15
12
10
45
40
35
30
25
5
0
Comparative Advantage
(a) United States
A
5 10 15 18 20 25
Wheat (Tons)
30
15
10
4
5
0
25
20
45
40
35
30
(b) Brazil
B
5 8 10 15 20
Wheat (Tons)
37-7

Comparative Advantage
• Self-sufficiency output mix
• Specialization and trade
• Produce good with lowest domestic opportunity cost
• Opportunity cost 1 ton wheat
–1 pound of coffee in U.S.
–2 pounds of coffee in Brazil
37-8

Comparative Advantage
• Terms of trade
–U.S. 1W = 1C
–U.S. will sell 1W for more than 1C
–Brazil 1W = 2C
–Brazil will pay less than 2C for 1W
–Settle between the two
–Depends on supply/demand factors
–Assume 1W = 1.5C
37-9

Comparative Advantage
• Gains from trade
–Trade possibilities line
–Slope equals terms of trade
–Improved options
• Complete specialization
• More of both goods
• More efficient resource allocation
37-10

Economic Basis for Trade
45 45
C’
40
(a) United States
40
(b) Brazil
35 35
30
C
Trading
Possibilities Line
25
30
25
20 c
Trading
Possibilities Line
20
A’
15
12
10
A
15
10
5
0
5 10 15 18 20 25
Wheat (Tons)
W
30
5
4
0
B’
5
B w w’
8 10 15
Wheat (Tons)
20
37-11

Benefits of Free Trade
• The case for free trade
–Promote efficiency
• If China can produce steel cheaper than the U.S., shouldn’t they?
• If the U.S. can create useful technology more efficiently than
China, shouldn’t they?
–Promote competition
• More and better stuff!
• Adapt or Die, right?
37-12

Costs of Free Trade
• What if you’re a steelworker in Pittsburgh?
• What if you’re a software developer in China?
• Americans benefit from cheaper steel, but the nightly news has no problem profiling the loss of steel jobs
• The benefits are spread out and hard to see, the harmed are easily identified
• Special interests will mobilize, seeking protection… examples?

Supply and Demand Analysis
• World price
• Domestic price with no trade
• World price > domestic price
–Export surplus
–Export supply curve
• World price < domestic price
–Import shortage
–Import supply curve
37-14

Supply and Demand Analysis
1.50
1.25
1.00
.75
.50
0
(a) U.S. Domestic
Aluminum Market
Surplus = 100
S d
Surplus = 50
(b) U.S. Export Supply and Import Demand
Shortage = 50
Shortage = 100
50 75 100 125
Quantity of Aluminum
(Millions of Pounds)
150
D d
1.50
1.25
b
U.S.
Export
Supply c
1.00
a
.75
.50
0 x
U.S.
Import
Demand y
50 100
Quantity of Aluminum
(Millions of Pounds)
37-15

Supply and Demand Analysis
(a) Canada’s Domestic
Aluminum Market
(b) Canada’s Export Supply and Import Demand
1.50
1.25
1.00
.75
.50
0
Surplus = 100
Surplus = 50
Shortage = 50
50 75 100 125
Quantity of Aluminum
(Millions of Pounds)
D d
150
S d
1.50
1.25
1.00
.75
q
.50
0 r
Canadian
Export
Supply t
Canadian
Import
Demand
50 100
Quantity of Aluminum
(Millions of Pounds) s
37-16

International Equilibrium
Import demand = Export supply
U.S.
Export
Supply
1.00
.88
.75
0 e
Canadian
Export
Supply
Equilibrium
U.S.
Import
Demand
Canadian
Import Demand
50 100
Quantity of Aluminum
(Millions of Pounds)
37-17

Trade Barriers
• Tariffs
–Revenue tariff
–Protective tariff
• Import quota
• Nontariff barrier (NTB)
–Licensing, standards, etc.
• Voluntary export restriction
(VER)
– Why would a producer voluntarily restrict their exports?
37-18

Trade Barriers
• Economic impact of tariffs
• Direct effects
–Decline in domestic consumption
–Increase in domestic production
–Decline in imports
–Tariff revenue
• Indirect effects
–Promote inefficiency
–Hurt growth
37-19

Trade Barriers
Economic Effects of a Tariff or Quota
1. Who/What benefits from the tariff?
2. Who/What suffers?
Free trade provides consumers with a higher quantity at a lower price!
S d
S d
+ Q
P d
P t
P w
What about a quota?
0
D d a b q
Quantity c d
37-20

The Case for Protection
• Different arguments – examples?
• Military self-sufficiency
• Diversification for stability
• Infant industry
• Protection against dumping
• Increased domestic employment
• Cheap foreign labor
37-21

• World Trade Organization has
151 member nations
–Liberalize trade through negotiation
• Protest groups
–Labor unions, environmentalists, socialists, anarchists
• Key issues for the protestors
–Labor protection and environmental standards
37-22

Key Terms
• labor-intensive goods
• land-intensive goods
• capital-intensive goods
• opportunity-cost ratio
• principle of comparative advantage
• terms of trade
• trading possibilities line
• gains from trade
• world price
• domestic price
• export supply curve
• import demand curve
• equilibrium world price
• tariffs
• revenue tariff
• protective tariff
• import quota
• nontariff barrier (NTB)
• voluntary export restriction
(VER)
• strategic trade policy
• dumping
• Smoot-Hawley Tariff Act
• World Trade Organization
(WTO)
• Doha Round
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