Chapter 16
International Trade and Globalization
After reading Chapter 16, INTERNATIONAL TRADE AND GLOBALIZATION, you should be able to:
• Discuss the concepts of Globalization and a Developing Economy.
• Explain why Specialization and the Law of Comparative Advantage are the basis for international
trade.
• Discuss the gains from trade and explain why the average person is made better off by international
trade.
• Explain how workers in high wage countries can compete with workers in low wage countries.
• Discuss the different types of Trade Barriers: Tariff, Import Quota and Voluntary Export Quota
and explain the costs of these trade barriers.
• Discuss arguments against and for protection.
• Describe the history of U.S. trade policies.
T Outline
I.
Globalization and Developing Economies
A) Participation in global markets depends on the ease of communication and the costs of
transporting goods and services long distances. Globalization is the degree to which national
markets and international businesses are integrated and interrelated into a world economy.
B) Per capita GDP is the most comprehensive measure of the level of economic development. A
Developing Country is a country with a per capita income well below that of a typical advanced
country. Around 75% of the world’s population live in a developing country. Only 15 percent of
the world’s population lives in the developed countries of the United States and Western
Europe, Canada, Australia, and Japan.
II.
The Law of Comparative Advantage and Gains from Trade
A) The theory of international trade, first developed by David Ricardo, shows that both rich and
poor countries gain from trade through Specialization—people will produce more of a good
than they can consume, and exchange the rest for other goods they want. Specialization arises
from the fact that factors of production have different characteristics.
B) Comparative Advantage means employing a resource in its best use. The Law of
Comparative Advantage states that people or countries gain if they specialize in those
activities at which they have the greatest advantage over other. If a person or country is superior
to all others in all things, the law of comparative advantage points out it is best for the person or
country to specialize in the one activity in which the margin of superiority is largest.
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C) Each country tends to produce and export goods in which its resource base gives it a
comparative advantage.
1. America has an abundance of highly skilled labor, so the United States tends to export goods
that require skilled labor and a lot of research and development to produce.
2. Low efficiency nations can compete with high efficiency countries because the workers in
the high efficiency nations receive higher wages than the workers in the low efficiency
countries.
D) Trade between countries is beneficial because the average citizen in all the countries is made
better off by the trade.
1. The average citizen gains because trade raises his or her income and lowers the prices of
imported goods.
2. Some people lose from the trade while others gain. But, the benefit to the gainers exceeds the
loss to the losers.
E) Trade will be beneficial even between high-wage countries and low-wage countries. Wage
differentials reflect differences in productivity, so low efficiency workers compete by working
at lower wages.
III. Trade Barriers
A) Trade barriers include tariffs, import quotas, and voluntary export quotas are ways to protect
domestic producers that restrain trade.
1. Tariffs are taxes levied on imports.
2. Import Quotas is a limit on the amount of a specific product that can be imported during a
given year.
3. Voluntary Export Quotas are agreements between two governments in which the exporting
country “voluntarily” limits the export of a certain product.
B) Trade barriers raise the price of the protected goods. Consumers demand fewer imported goods
and the domestic production of import-competing goods rises.
C) When a country restricts its imports, it necessarily lowers its exports since in the long run a
nation’s exports pay for its imports. Thus trade barriers lower output in export industries.
D) Trade barriers harm the average citizen. They are imposed because the benefits they create are
concentrated among a few sectors, while their costs are widely diffused throughout the society.
E) A common protectionist argument in favor of trade barriers is that industries need protection
from unfair foreign competitors who pay their workers low wages.
1. Industries with a comparative advantage can compete even with low foreign wages.
2. Industries in which a country does not have a comparative advantage are unable to compete
with foreign firms.
3. If noncompetitive industries are protected, jobs are lost in competitive industries and the
standard of living is lowered.
IV. American Trade Policies
A) Tariffs have fluctuated up and down. They reached their peak in 1930 as a result of the SmootHawley Act. This act led to retaliatory trade barriers around the world, leading to a decline in
world trade volume.
B) The Reciprocal Trade Agreement Act of 1934 amended the Smoot-Hawley Act and allowed the
President to lower tariffs when foreign countries agreed to lower their tariffs.
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159
C) The Trade Expansion Act of 1962 gave the President further powers to lower tariffs.
D) The Trade Reform Act of 1974 resulted in a further reduction of tariffs.
E) Since 1932, the average tariff has fallen from about 59 percent to less than 5 percent.
T Review Questions
True/False
If the statement is correct, write true in the space provided; if it is wrong, write false. Below the question
give a short statement that supports your answer.
_____
1.
The law of comparative advantage states that a person should do what he or she does best
without regard to the skills of other people.
_____
2.
If people and countries follow the law of comparative advantage, they tend to specialize in
the production of relatively few items.
_____
3.
Everyone in a country directly gains from international trade.
_____
4.
The average person in a country gains from international trade.
_____
5.
A tariff is a quantitative limit on the amount of a good that may be imported into a country
during a given period.
_____
6.
Countries tend to import goods in which they have a comparative advantage.
_____
7.
The United States has a comparative advantage in manufacturing nonstandardized, new
products.
_____
8.
International trade reduces the prices of goods that will be imported into the country.
_____
9.
An import quota is an example of a nontariff trade barrier.
_____
10. When a country specializes in producing the products in which it has a comparative
advantage, the country’s income is maximized.
_____
11. Voluntary export quotas have no effect on prices paid by domestic consumers.
_____
12. If a country restricts its imports, it also restricts the amount it can export.
_____
13. In the past 50 years, tariffs have steadily increased.
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Multiple Choice Questions
Circle the letter corresponding to the correct answer.
1.
The cost of restricting imports into a country is
(a) a loss of jobs in export industries.
(b) a fall in the standard of living.
(c) a decrease in the number of goods that can be consumed.
(d) a fall in average income.
(e) all of the above.
2.
The American government program that raised tariffs to their highest level was the
(a) Smoot-Hawley Act.
(b) the Reciprocal Trade Agreement.
(c) the Trade Expansion Act.
(d) the Trade Reform Act.
(e) the Tokyo Round.
3.
The law of comparative advantage suggests all of the following except
(a) nations and individuals tend to produce only a few items.
(b) the United States tends to export new products requiring a lot of research and development.
(c) trade barriers harm the people within the nation erecting the barriers.
(d) nations will be better off if they protect their industries that have a comparative disadvantage.
(e) nations tend to export goods in which they have an abundance of the necessary factors of
production.
For the next 6 questions, use the following table:
Country
A
B
Wheat Produced Using
1 Hour of Labor
3 Bushels
9 Bushels
Books Produced Using
1 Hour of Labor
12 Books
18 Books
4.
Before trade, in Country A, 1 bushel of wheat costs how many books?
(a) 1
(b) 2
(c) 4
(d) 12
(e) It is impossible to tell from the table.
5.
Before trade, in Country B, 1 bushel of wheat costs how many books?
(a) 1
(b) 2
(c) 4
(d) 12
(e) It is impossible to tell from the table.
Chapter 16
International Trade and Globalization
6.
Country B has a comparative advantage in the production of
(a) wheat.
(b) books.
(c) neither wheat nor books.
(d) both wheat and books.
(e) It is impossible to tell from the table.
7.
Country A has a comparative advantage in the production of
(a) wheat.
(b) books.
(c) neither wheat nor books.
(d) both wheat and books.
(e) It is impossible to tell from the table.
8.
Before trade, in Country B wheat is _________ compared to Country A, so Country B _________
wheat.
(a) inexpensive; exports
(b) inexpensive; imports
(c) expensive; imports
(d) expensive; exports
(e) the same price; may import or export
9.
Before trade, in Country A _________ is (are) inexpensive compared to Country B, so Country A
exports _________.
(a) books; books
(b) books; wheat
(c) wheat; books
(d) wheat; wheat
(e) nothing; nothing
Essay Questions
Write a short essay or otherwise answer each question.
1.
What is a common argument in favor of protectionist policies? What are the costs of protectionist
policies?
2.
Suppose a foreign country was willing to give steel away in the United States. Would you favor a
tariff on imported steel if you were a steelworker? If you were an auto worker? (Manufacturing
automobiles requires a lot of steel.)
For the next 5 questions, use the following table.
United States
Korea
3.
Computers Produced Using
1 Hour of Labor
4 Computers
1 Computer
Shirts Produced Using
1 Hour of Labor
8 Shirts
4 Shirts
In the United States, before trade, what is the price of 1 computer in terms of shirts? What is the
Korean price of computers?
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4.
The United States has a comparative advantage in which good? This good is cheaper in which
country?
5.
Korea has a comparative advantage in which good? The United States is more efficient than Korea in
producing both goods, since an hour of labor produces more computers and more shirts in the United
States. How is it possible for Korea to have a comparative advantage and export anything to the
United States?
6.
What is the after-trade price of computers?
7.
Suppose the United States transfers 1 hour of labor from shirts to computers while Korea switches 3
hours of labor from computers to shirts. What is the net effect of these changes on world output of
computers and shirts? Does specialization increase overall production of goods?
8.
The following statement is often made by people in developed countries: “We cannot compete with
foreign producers because their wages are too low. Thus we need to protect our industries.” Also, the
following assertion is made by people in less-developed countries: “We cannot compete with foreign
producers because their level of technology is too high. Thus we need to protect our industries.”
Evaluate these claims.
T Answers to Review Questions
True/False
1.
False. The law of comparative advantage states that people should specialize in things in which their
advantage relative to others is greatest.
2.
True. Countries and people specialize in producing only the few things for which they are best suited.
They trade with other (specialist) producers for most of their consumption goods.
3.
False. The people and firms that compete with imported goods can be harmed by trade.
4.
True. Question 3 points out that some people may be harmed by trade. But most people gain from
trade so that, on net, the average person benefits from trade.
5.
False. A tariff is a tax levied on goods imported into a nation; an import quota is a quantitative limit
on the amount that may be imported.
6.
False. Countries export goods in which they have a comparative advantage.
7.
True. Because the United States has a comparative advantage in these goods, we should expect
(correctly) that it exports this type of product.
8.
True. This price reduction is one of the ways the average person gains from trade.
9.
True. Other examples are voluntary export quotas and tariffs.
10. True. This is effectively the reason why free trade according to comparative advantage makes every
nation better off.
11. False. Voluntary export quotas, like all barriers to trade, raise the prices paid by domestic consumers
for imported goods.
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163
12. True. This is part of the cost imposed by protectionist barriers to trade.
13. False. In the past fifty years, tariffs generally have fallen.
Multiple Choice Questions
1.
(e) All of these are costs inflicted on society by protectionist measures that limit the amount of
imports.
2.
(a) The Smoot-Hawley tariff was passed in 1930 and may have contributed to worsening the Great
Depression. It has been relaxed with amendments starting in 1934.
3.
(d) The law of comparative advantage points out that the country ought to let other nations produce
the goods in which it has a comparative disadvantage and produce only the things in which it has
a comparative advantage.
4.
(c) In Country A, to produce 1 bushel of wheat requires 1/3 of an hour. Thus 1 bushel of wheat
requires the sacrifice of 4 books, the number of books produced in 1/3 hour. Therefore, in
country A 1 bushel of wheat costs 4 books.
5.
(b) In Country B, to produce 1 bushel of wheat requires 1/9 of an hour so there are 2 books lost to
produce a bushel of wheat. Hence, the price of a bushel of wheat is 2 books in country B.
6.
(a) Country B is 3 times more productive in producing wheat than Country A. (In one hour of time,
B produces 9 bushels while A can grow only 3.) Country B is only 1.5 times more efficient than
A in manufacturing books, so B’s greatest advantage lies in wheat. Compare this with the
answers from questions 4 and 5, and you can see that this comparative advantage is reflected in a
lower pre-trade price of books in country B.
7.
(b) While Country B can produce both goods more efficiently than Country A, A’s relative
disadvantage is less in book production. Therefore, A has comparative advantage in producing
books.
8.
a. Questions 4 and 5 demonstrated that in Country A, a bushel of wheat costs 4 books while in country
B a bushel of wheat costs only 2 books. Wheat is cheaper in country B, so B exports wheat to
country A. This is a specific example of the general proposition that before trade the product in
which a country has a comparative advantage is cheap compared to its price in other countries.
9.
(a) Before trade, a book in country A costs 1/4 of a bushel of wheat and costs 1/2 a bushel of wheat
in country B. (These prices are calculated analogously to those in Questions 4 and 5.) Hence,
books are cheaper in A and so country A exports books.
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Essay Questions
1.
The most commonly encountered argument is that it is impossible to compete with foreign nations
because the wages paid to foreign workers are too low. Protectionist policies harm society in a variety
of ways: they raise the cost of imported goods, they lower employment in the export industries, they
lower the nation’s real income, and they lower the welfare of the nation.
2.
If you were a steelworker, you would favor a tariff to help protect your job. If you were an auto
worker, you probably would oppose a tariff: If the price of steel in the United States were lower, the
price of American-made cars would be lower, so your job would be more secure. This question points
out the important fact that even though international trade benefits the nation as a whole, it harms
some sectors and some people.
3.
In the United States, 1 computer costs 2 shirts: to produce 1 computer reduces the number of shirts by
2. In Korea, 1 computer costs 4 shirts.
4.
The United States has a comparative advantage in computers. It is 4 times more productive in
producing computers and only 2 times more productive in producing shirts. The price of computers is
cheaper in the United States. This reflects the comparative advantage the United States enjoys in
computers.
5.
Korea has a comparative advantage in producing shirts. Manufacturing shirts minimizes the
disadvantage Korea faces in both products. Korea can export shirts to the United States because the
price of shirts is lower in Korea than in the United States. Before trade, 1 shirt costs only 1/4
computer in Korea but 1/2 computer in the United States. Since the price of shirts is lower in Korea,
Korea can successfully export them.
6.
We do not know what the price of computers is after trade. We do know that the price is less than (or
equal to) 4 shirts and more than (or equal to) 2 shirts. In order to determine the precise post-trade
price, we need more information about demand for the goods in the countries.
7.
8.
Computers: (+4) in the United States plus (–3) in Korea = +1 computer.
Shirts: (–8) in the United States plus (+12) in Korea = +4 shirts.
These results show that specialization corresponding to the law of comparative advantage raises total
world output in all products.
These assertions obviously are related, and both are false. Developed countries can compete
successfully with low-wage countries in those industries in which their technological lead gives them
a comparative advantage. Basically, the high technology offsets the high wages in developed
countries. Less-developed countries can compete in those industries in which their low wages offset
the technological lead of advanced countries. Both developed and less-developed countries have
industries with comparative advantages and industries with comparative disadvantages.
Chapter 16
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165
T Additional Questions
1.
The table below shows the number of units of steel and fish that can be produced with one hour of
labor in Japan and the United States.
Output from One Hour’s Work: United States and Japan
Country
Fish Output per Hour Steel Output per Hour
United States
100
25
Japan
50
50
(a)
(b)
(c)
(d)
What is the fish price of steel in the United States? What is the steel price of fish?
What is the fish price of steel in Japan? What is the steel price of fish?
Which country should specialize in fish and which country should specialize in steel? Explain.
Suppose that the United States transfers one hour from steel production to one hour of fish
production and Japan transfers one hour of fish production to steel production. By how much
does the total production of steel and fish change?
2.
Consider the information from problem #1.
(a) What is the range of possible steel prices in terms of fish such that both countries will be better
off with trade than without? Explain.
(b) Suppose the United States has 1,000 hours of labor that it devotes to producing the good in which
it specializes. If it trades half of the goods it produces explain by example—choose an exchange
rate—that it is better off with trade than without.
(c) Illustrate your answer from (b) on a production possibility frontier diagram.
3.
Suppose the international price of cheese is $5 and the international price of wine is $10. A worker in
France can earn $15 per day in cheese and $60 per day in wine. A worker in Italy can make $25 per
day in cheese and $50 per day in wine.
(a) Construct a table that shows the production possibilities for each country.
(b) Which country has the comparative advantage in cheese? in wine?
Answers
1.
(a) In the United States 1S = 4F and 1F = ¼ S.
(b) In Japan 1S = 1F and 1F = 1S.
(c) Since the price of steel in terms of fish in Japan is less than in the United States, Japan has a
comparative advantage in steel production and therefore, should specialize in steel production.
Likewise, the United States has a lower price for fish in terms of steel so should specialize in fish
production.
(d) The United States will lose 25 steel but gain 100 fish. Japan will lose 50 fish but gain 50 steel.
Therefore, total steel production will increase by 25 and total fish production will increase by 50.
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2.
(a) The price of steel will be in between one fish and four fish since those are the two domestic steel
prices.
(b) If the United States has 1,000 hours of labor it will be able to produce 100,000 units of fish. The
United States will, therefore, sell 50,000 fish. As long as one steel trades for between one and
four fish, the United States will be better off with trade. For example, suppose 1S = 2F. For the
50,000 fish the United States will receive 25,000 steel. Therefore, after trade they will have
50,000 fish and 25,000 steel. If the United States worked alone and did not trade they could
produce 50,000 fish and 12,500 steel. Thus, with trade they can increase their steel consumption
by 12,500 units and still have 50,000 fish.
(c)
3.
(a)
Output from One Day’s Work: France and Italy
Country
France
Italy
Cheese Output per Day
3
5
Wine Output per Day
6
5
(b) The price of cheese in France is two wine, while the price of cheese in Italy is one wine. Since
the price of cheese is lower in Italy, they have the comparative advantage in cheese production.
Similarly, France has the comparative advantage in wine production.