Chapter 33
The Gains
from
International
Trade
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In this chapter you will learn to
1. Explain why the gains from trade depend on the pattern
of comparative advantage.
2. Describe the effects of factor endowments and climate on a
country’s comparative advantage.
3. Explain the relationship between the law of one price and
trade patterns.
4. Describe some of the reasons why countries export certain
goods and import others.
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Figure 33.1 The Growth in
World Trade, 1950–2005
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Figure 33.2 U.S. Exports and Imports
of Goods by Industry, 2005
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The Gains from Trade
Interpersonal, Interregional, and International
Trade
Without trade, people must be self-sufficient.
With trade, people can specialize efficiently and satisfy other
needs by trading.
This basic principle is true for individuals, regions, and
countries:
 the gains from trade
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Table 33.1 Absolute Costs and
Absolute Advantage
Illustrating the Gains from Trade
One country has an absolute advantage in the production of a
specific product if, relative to another country, it can produce
one unit of the product using fewer resources.
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Table 33.2 Opportunity Costs
and Comparative Advantage
One country has a comparative advantage in the production of
a specific product if, relative to another country, its opportunity
cost for producing the product is lower.
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Table 33.3 The Gains from
Specialization
World production of all products can be increased if each
country specializes in producing the goods for which it has a
comparative advantage.
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Figure 33.3 The Gains from Trade
with Constant Opportunity Costs
Canada specializes in wheat, the EU specializes in cloth.
 consumption possibilities increase in both countries
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Conclusions about Gains from Trade
1. If Country A has a comparative advantage in one
product then it must have a comparative disadvantage
in another.
2. The opportunity cost of one product is not its absolute
cost, but the amount of output of other products that
must be sacrificed.
3. When opportunity costs are the same in all countries,
there are no gains from specialization and trade.
4. When opportunity costs differ across both countries,
global production can be increased by reallocating
resources.
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Gains from Trade Without Complete
Specialization
EXTENSIONS IN THEORY 33.1
The Gains from Trade Without Complete
Specialization
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The Gains from Trade with Variable
Costs
Additional gains from trade may be possible:
Economies of scale:
International trade allows small countries to produce
high enough levels of output to reap the available scale
economies.
Learning by doing:
Costs may fall as production experience
increases.
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Figure 33.4 Economics of Scale
versus Learning by Doing
Scale economies
are shown by the
downward sloping
LRAC curve.
Learning by doing
implies that LRAC
curves shift down as
experience increases.
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Sources of Comparative Advantage
Factor endowments. Countries have the CA in products that
use their abundant resources relatively intensively.
Climate. Variation in national climates affects comparative
advantages. Climate can be considered a “special” factor of
production.
Acquired. Comparative advantage can be acquired or lost
over time. It is a dynamic concept.
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Contrasting Views
The traditional view: A government should encourage
specialization of production in goods for which it currently
has a comparative advantage.
• each country should specialize in a relatively narrow
range of distinct products.
The modern view: If comparative advantage can be acquired,
it can also be lost.
• each country should innovate and adopt the latest
technologies
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The Determination of Trade Patterns
The Law of One Price
- when an easily transported product is internationally
traded, arbitrage guarantees a single world price
Compare the world price with the U.S. domestic price:
1. If pw > pd  U.S. exports the product
2. If pw < pd  U.S. imports the product
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Figure 33.5 An Exported Good
Countries export
goods whose world
price exceeds the
domestic price.
 Countries export
the goods for which
they are low-cost
producers.
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Figure 33.6 An Imported Good
Countries import
products whose
world price is less
than the domestic
price.
 Countries import
goods for which they
are high-cost
producers.
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Is Comparative Advantage Obsolete?
The theory that comparative advantage determines trade
flows is not obsolete.
But the idea that comparative advantage is completely
determined by forces beyond the reach of public policy has
been discredited.
Although governments may influence patterns of comparative
advantage, it is not necessarily advisable:
- compare the costs of trade-related policies with their
likely benefits
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The Terms of Trade
The division of the gains from trade depends on the terms of
trade.
The terms of trade are measured by the ratio of the price of
exports to the price of imports.
Terms of Trade
=
Index of Export Prices
Index of Import Prices
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x 100
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Figure 33.7 A Change in the
Terms of Trade
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A Change in the Terms of Trade
A rise in the index:
 country gets more imports per unit of exports
 a favorable change for the country
A fall in the index:
 country gets fewer imports per unit of exports
 an unfavorable change for the country
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Figure 33.8 U.S. Terms of
Trade, 1961–2006
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