Economics: Principles and
Applications, 2e
by Robert E. Hall &
Marc Lieberman
© 2001 South-Western, a division of Thomson Learning
Chapter 16:
Comparative Advantage
and the Gains from Trade
© 2001 South-Western, a division of Thomson Learning
The Logic of Free Trade
Exports
Goods and services produced domestically,
but sold abroad.
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The Logic of Free Trade
Imports
Goods and services produced abroad, but
consumed domestically.
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The Theory of
Comparative Advantage
•Opportunity Cost and Comparative Advantage
•Specialization and World Production
•Gains from International Trade
•The Terms of Trade
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The Theory of
Comparative Advantage
Absolute Advantage
The ability to produce a good using fewer
resources than another country.
© 2001 South-Western, a division of Thomson Learning
The Theory of
Comparative Advantage
Comparative Advantage
The ability to produce a good at a lower
opportunity cost than another country.
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The Theory of
Comparative Advantage
If countries specialize according to
comparative advantage, a more efficient use
of given resources occurs.
© 2001 South-Western, a division of Thomson Learning
The Theory of
Comparative Advantage
As long as opportunity costs differ,
specialization and trade can be beneficial to
all involved. This is true even if one party has
an all-round absolute advantage or
disadvantage.
© 2001 South-Western, a division of Thomson Learning
The Theory of
Comparative Advantage
Terms of Trade
The ratio at which a country can trade
domestically produced products for foreignproduced products.
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Turning Potential Gains into
Actual Gains
Exchange Rate
The amount of one currency that is traded for
one unit of another currency.
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Turning Potential Gains into
Actual Gains
Some Important Provisos
•Costs of Trading
•Size of Countries
•Increasing Opportunity Cost
•Government Barriers to Trade
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The Sources of
Comparative Advantage
Countries often specialize in products based
on their own particular endowments of
natural resources. But natural resources are
not the only basis for comparative advantage.
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The Sources of
Comparative Advantage
Countries often develop strong comparative
advantages in the goods they have produced
in the past, regardless of why they began
producing those goods in the first place.
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Why Some People Object to
Free Trade
•The Impact of Trade in the Exporting Country
•The Impact of Trade in the Importing Country
•Attitudes Toward Free Trade: A Summary
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Why Some People Object to
Free Trade
When the opening of trade results in increased
exports of a good, the producers of the good are
made better off and will support increased trade.
Consumers of the good will be made worse off and
will oppose increased trade.
© 2001 South-Western, a division of Thomson Learning
Why Some People Object to
Free Trade
When the opening of trade results in increased
imports of a product, the domestic producers of
the product are made worse off and will oppose the
increased trade. Consumers are better off and will
favor the increased trade.
© 2001 South-Western, a division of Thomson Learning
How Free Trade
Is Restricted
•Tariffs
•Quotas
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How Free Trade
Is Restricted
Tariff
A tax on imports.
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How Free Trade
Is Restricted
Tariffs reduce the volume of trade and raise the
domestic prices of imported goods. In the country
that imposes the tariff, producers gain and
consumers lose. But the world as a whole loses
because tariffs decrease the volume of trade and
therefore decrease the gains from trade.
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How Free Trade
Is Restricted
Quota
A limit on the physical volume of imports.
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How Free Trade
Is Restricted
Quotas have effects similar to tariffs--they reduce
the quantity of imports and raise domestic prices.
While both measures help domestic producers, they
reduce the benefits of trade to the nation as a
whole.
Protectionism
•Myths About Free Trade
•Sophisticated Arguments for Protection
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Protectionism
Protectionism
The belief that a nation’s industries should be
protected from foreign competition.
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Protectionism
“A high-wage country cannot afford free trade with a lowwage country.”
•“A low-productivity country cannot afford free trade with a
high-productivity country.”
•“In recent times, America’s unskilled workers have
suffered because of ever-expanding international trade.”
© 2001 South-Western, a division of Thomson Learning
Protectionism
According to strategic trade policy, a nation can
gain in some circumstances by assisting certain
“strategic” industries that benefit society as a
whole, but that may not thrive in an environment of
free trade.
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Protectionism
Production is most likely to reflect the principle of
comparative advantage when firms can obtain
funds for investment projects and when they can
freely enter industries that are profitable. Thus, free
trade, without government intervention, works best
when markets are working well.
© 2001 South-Western, a division of Thomson Learning