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TOPIC 11
INTERNATIONAL TRADE
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International Trade
• All economies, regardless of their size, depend
to some extent on other economies and are
affected by events outside their borders.
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The Economic Basis for Trade:
Comparative Advantage
• A country enjoys a comparative advantage in
the production of a good when that good can be
produced at a lower cost in terms of other goods.
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Absolute Advantage
versus Comparative Advantage
• A country enjoys an absolute advantage over
another country in the production of a product
when it uses fewer resources to produce that
product than the other country does
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Gains from Mutual Absolute Advantage
Yield Per Acre Of Wheat And Cotton
NEW ZEALAND
AUSTRALIA
Wheat
6 bushels
2 bushels
Cotton
2 bales
6 bales
•New Zealand can produce three times the wheat
that Australia can on one acre of land, and
Australia can produce three times the cotton.
•We say that the two countries have mutual
absolute advantage.
Gains from Mutual Absolute Advantage
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• Suppose that each country divides its land to
obtain equal units of cotton and wheat production
as shown below:
Total Production Of Wheat And Cotton Assuming No Trade,
Mutual Absolute Advantage, And 100 Available Acres
NEW ZEALAND
AUSTRALIA
Wheat
25 acres x 6 bushels/acre
150 bushels
75 acres x 2 bushels/acre
150 bushels
Cotton
75 acres x 2 bales/acre
150 bales
25 acres x 6 bales/acre
150 bales
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Production Possibility Frontiers for
Australia and New Zealand Before Trade
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Gains from Mutual Absolute Advantage
• An agreement to trade 300 bushels of wheat for 300
bales of cotton would double both wheat and cotton
consumption in both countries.
Production and Consumption of Wheat and Cotton after Specialization
PRODUCTION
New Zealand
Wheat
Cotton
100 acres x 6 bu/acre
600 bushels
0 acres
0
Australia
0 acres
0
100 acres x 6 bales/acre
600 bales
CONSUMPTION
New
Zealand
Australia
300 bushels
300 bushels
300 bales
300 bales
Expanded Possibilities after Trade
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•Because both countries have an absolute
advantage in the production of one product,
specialization and trade will benefit both.
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Gains from Comparative Advantage
• Even if a country had a considerable absolute
advantage in the production of both goods,
Ricardo would argue that specialization and
trade are still mutually beneficial.
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Gains from Comparative Advantage
• Assume that people in each country want to
consume equal amounts of cotton and wheat,
and that each country is constrained by its
domestic production possibilities curve, as
follows:
Yield Per Acre of Wheat and Cotton
Wheat
Cotton
NEW ZEALAND
AUSTRALIA
6 bushels
6 bales
1 bushel
3 bales
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Gains from Comparative Advantage
Total Production of Wheat and Cotton Assuming No Trade and
100 Available Acres
NEW ZEALAND
AUSTRALIA
Wheat
Cotton
50 acres x 6 bushels/acre
300 bushels
75 acres x 1 bushels/acre
75 bushels
50 acres x 6 bales/acre
300 bales
25 acres x 3 bales/acre
75 bales
•The gains from trade in this example can be
demonstrated in three stages.
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Realizing a Gain from Trade When One Country Has
a Double Absolute Advantage
Stage 1: Countries specialize
STAGE 1
Wheat
Cotton
New Zealand
Australia
50 acres x 6 bushels/acre
300 bushels
0 acres
0
50 acres x 6 bales/acre
300 bales
100 acres x 3 bales/acre
300 bales
•Australia transfers all its land into cotton production.
New Zealand cannot completely specialize in wheat
production because it needs 300 bales of cotton and
will not be able to get enough cotton from Australia (if
countries are to consume equal amounts of cotton
and wheat).
Realizing a Gain from Trade When One
Country Has a Double Absolute
Advantage
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STAGE 2
New Zealand
Australia
Wheat
75 acres x 6 bushels/acre
450 bushels
0 acres
0
Cotton
25 acres x 6 bales/acre
150 bales
100 acres x 3 bales/acre
300 bales
•New Zealand transfers 25 acres out of cotton and
into wheat.
Realizing a Gain from Trade When One
Country Has a Double Absolute
Advantage
STAGE 3
New Zealand
Australia
100 bushels (trade)
Wheat
350 bushels
100 bushels
(after trade)
200 bales (trade)
Cotton
350 bales
100 bales
(after trade)
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Gains from Comparative Advantage
• The real cost of producing cotton is the wheat
that must be sacrificed to produce it.
• A country has a comparative advantage in cotton
production if its opportunity cost, in terms of
wheat, is lower than the other country.
Comparative Advantage
Means Lower Opportunity Cost
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• Both Australia and New Zealand will gain when
the terms of trade are set
between 1:1 and 3:1,
cotton to wheat.
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Terms of Trade
• The ratio at which a country can trade domestic
products for imported products is the terms of
trade.
• The terms of trade determine how the gains from
trade are distributed among trading partners.
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Trade Barriers
• Protection is the practice of shielding a sector of the
economy from foreign competition.
• A tariff is a tax on imports.
• A quota is a limit on the quantity of imports.
• Export subsidies are government payments made to
domestic firms to encourage exports.
• Dumping refers to a firm or industry that sells products
on the world market at prices below the cost of
production.
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The Case for Protection
• Protection saves jobs
• Some countries engage in unfair trade
practices
• Cheap foreign labor makes competition unfair
• Protection safeguards national security
• Protection discourages dependency
• Protection safeguards infant industries