International Trade
ECO 285 – Macroeconomics – Dr. D. Foster
International Trade
Basis for trade:
Comparative Advantage
Who has the lower “opportunity cost?”
Mistaken basis for trade:
Absolute Advantage
Who has the lower resource cost?
Example: Absolute Advantage
Consider Senegal and Peru:
Senegal
Peru
Resource Units to produce:
Wool (#)
Beef (#)
2.5
1
3
2
# of R.U.
100,000
150,000
Who can more cheaply produce wool?
Who can more cheaply produce beef?
# = pounds
Example: Comparative Advantage
Reconsider Senegal and Peru:
Senegal
Peru
Maximum production of:
Wool (#)
Beef (#)
40,000
100,000
50,000
75,000
What does it “cost” to produce wool?
What does it “cost” to produce beef?
Comparative Advantage
Opportunity costs in Senegal and Peru:
Senegal
Peru
Opportunity Cost:
1# Wool
1# Beef
2.50
0.40
1.50
0.67
in # beef
in # wool
With trade, wool would “sell” for . . .?
With trade, beef would “sell” for . . .?
Price = Terms of Trade; say 1# W=2# B
Trade Observations
Not all countries have absolute advantages.
All countries do have comparative advantages.
Country size is irrelevant.
Opportunity cost = what you give up.
The international trading price of goods is
called the “terms of trade.”
Back to Senegal/Peru trade example:
Assume without trade, resources are split evenly.
Senegal always wants 50,000 #B;
Peru always wants 25,000 #W.
Advantages to Trade
#Wool
Senegal
40,000
20,000
#Wool
50,000
A
25,000
Peru
B
A
B
#
50,000 100,000 Beef
37,500 75,000
#
Beef
A - the “no trade” outcome; production=consumption
B - the specialized production outcome, with trade
Advantages to Trade
#Wool
Senegal
40,000
25,000
#Wool
50,000
C
25,000
B
Peru
C
B
#
50,000 100,000 Beef
75,000
50,000
#
Beef
A - the “no trade” outcome; production=consumption
B - the specialized production outcome, with trade
C - the consumption outcome, with trade.
Advantages to Trade
Before trade, world production was:
Wool: 45,000 lbs.
Beef: 87,500 lbs.
With trade, world production has become:
Wool: 50,000 lbs.
Beef: 100,000 lbs.
Gains to trade:
Wool: +5,000 lbs.
Beef: +12,500 lbs.
Effects of Trade Barriers
In Senegal, unrest among the shepherds.
Workers must relocate.
Owners must relocate.
Politicians seek to “protect” domestic
producers. Here, wool . . .
Consider two trade barriers –
an import quota and a tariff.
Policy #1 - Import Quota
#Wool Senegal
40,000
22,000
12,000
TheyUse
can remaining
only trade
20,000#,
resources
so they
to produce
only
Trade
produce
12,000
70,000#
# W.B.
Q* 20,000# B for
10,000# W.
Q
#
100,000 Beef
50,000
70,000
#Wool
Peru
50,000
35,000
25,000
Q
22,500
Limit imports to 10,000 pounds of wool.
Now, neither can completely specialize.
Each has a lower standard of living.
They can only trade
10,000#,
they
This
takes so
70%
of only
their
produce
35,000#.
RUs, so rest is used to
They can only
produce beef.
get 20,000# B
Q*
in trade.
75,000
42,500
#
Beef
World production:
Wool: 47,000#
Beef: 92,500#
Policy #2 - Tariff
#Wool Senegal
#Wool
50,000
47,222
40,000
22,222
F*
50,000# B
now22,222#
“cost”
But,
22,222#
wool willW!!
still
(50,000/2.25)
earn Peruvians
44,444# beef.
Peru
F
25,000
F*
F
#
50,000 100,000 Beef
4,167
Tariff (tax) changes ToT: 1# W = 2.25# B
Tax goes to government of Senegal.
But, still no domestic wool production!
75,000
48,611
#
Beef
World production:
Wool: 47,222#
Beef: 100,000#
Advantages to Trade & Disadvantages to Trade Barriers
Before trade, world production was:
Wool: 45,000 lbs. Beef: 87,500 lbs.
With trade, world production was:
Wool: 50,000 lbs. Beef: 100,000 lbs.
With tariff, world production was:
Wool: 47,222 lbs. Beef: 100,000 lbs.
With quota, world production was:
Wool: 47,000 lbs. Beef: 92,500 lbs.
International Trade
Basis for trade:
Comparative Advantage
Who has the lower “opportunity cost?”
Every country has a C.A. in some good.
Mistaken basis for trade:
Absolute Advantage
Who has the lower resource cost?
Not every country has an A.A. in some good.
Trade Lessons
We trade on the basis of our comparative
advantage.
Everyone has a comparative advantage.
Trade raises our material standard of living.
Trade barriers lower our standard of living.
Responding to trade barriers
in kind makes us worse off.
Trade Barriers
Import quotas to keep foreign goods out.
Tariffs that serve as a tax on foreign goods.
Subsidies for producers of export goods.
Impose standards on foreign goods ( costs).
The false rhetoric of protection:
cheap foreign labor, infant industry,
national defense, beggar-thy-neighbor
Bob Murphy on the 5 most common
myths about free trade.
1. We have free trade.

When our “free” trade bills are 1000 pages …
2. Trade deficits are bad.

The trade flow is equally offset by the capital flow.
3. Trade only helps poorer countries.

Does “Buy American” make us richer? Not “us!”
4. Free trade destroys jobs.

Odd sentiment vis-á-vis Texas & Mexico; Bastiat & candlemakers.
5. Free trade creates jobs.

No, it raises average wages and our standard of living.
Trade Fundamentals
We have different categories of trade:
Goods
Services
Merchandise
Trade Balance
Net Exports, aka
Current
Acct. of
Balance
Payments
Financial Account
• Value of assets.
• Net change in securities.
• Other.
Balancing error
Goods
Ex Im
Services
Ex Im
Net
Financial
error
2013 Q4: (405.4 b – 577.2 b) + (173.7 b – 115.8 b) + 173.7 b – 92 b
Net Ex: Feb. 2015: (125.6 – 180.8) + (60.6 – 40.9) = -35.4 b
Trade Fundamentals
Financial Account
Current Account
The Role of Trade in the Government’s Budget
GDP = C + I + G + (Ex-Im)
NI = C + S + T … and by definition GDP=NI [National income]
C + I + G + (Ex-Im) = C + S + T
Rearrange: G = T + (S-I) + (Im-Ex)
All government spending comes from:
Tax revenue raised.
Net private sector savings.
Net foreign sector savings. [i.e., the trade deficit]
Or, (G-T) = (S-I) + (Im-Ex)
The gov’t deficit = crowded out investment + trade deficit
International Trade
ECO 285 – Macroeconomics – Dr. D. Foster
The Trouble With Economic Statistics
Poorly defined … poverty, inequality, price level
Imprecise … discrepancy statistic for trade
Flawed … include G in GDP? GDE better?
Misleading … trade deficits bad? WWII prosperity?
Why? Data used to justify government policies.
Why? Market can’t fix problems; government can.
Who tells us this? Bureaucracy, politicians, elected officials.
“We must carefully distinguish between what we think
we know and what we really do and can know.” -O.M.
What is the legitimate role of government?
Let bad firms/banks go bankrupt.
We don’t lose real resources!!!!!
Abolish Fannie & Freddie.
End the Fed.
End the government monopoly on
money.
Get on the mailing list for Fall 2015 – dennis.foster@nau.edu
The W.A. Franke College of Business
Northern Arizona University
Spring 2016
ECO 481:
Public Choice Theory
W h y
G o v e r n m e n t
F a i l s
Dr. Dennis Foster
FCB #208