International Trade
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014
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?
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.
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
International Trade
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014