International Economy
International Economy
 What is trade? It is the act of buying and selling
goods and services.
 The main difference between domestic trade and
international trade is that the later is more
controversial.

Most polls show that Americans viewing economic
liberalization positively, but this can range from a plurality to a
large majority, depending on the poll.
 Trade makes use better off. It increases GDP, but it
does create winners and losers. However, the gains
often offset the losses.
International Trade
 International Trade has grown tremendously over
the past 50 years.

Significant decreases in quotas and tariffs.
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In the 1930’s, the average tariff rate was 50%. Today, it is less
than 2%.
Increases in Free Trade Agreements
The rise of neoliberalism with the fall of the Communist bloc
International Trade
U.S. International Trade
 U.S. exports for 2011 - $1.511 trillion
 Agricultural (soybean, fruit, corn) ~ 9.2%
 Industrial Supplies (organic chemical) ~ 26.8%
 Capital Goods (transistors, aircrafts, motor vehicle parts,
computers and telecommunication) ~ 49%
 Consumer goods (medicine and cars) ~15%
 Export Partners
 Canada 19.4%, Mexico 12.8%, China 7.2%, Japan 4.7% (2010)
Source: CIA World Factbook
U.S. International Trade
 U.S. imports for 2011 - $2.314 trillion
 Agricultural product ~4.9%
 Industrial Supplies ~ 32.9%, crude oil ~8.2%
 Capital Goods (computers, telecommunications equipment,
motor vehicle parts, office machines, electric power
machinery) ~ 30.4%
 Consumer goods (automobiles, clothing, medicines, furniture,
toys) ~ 31.8%
 Import Partners
 China 19.5%, Canada 14.2%, Mexico 11.8%, Japan 6.3%,
Germany 4.3% (2010).
Comparative Advantage
 Comparative Advantage – Ability of an economic
agent to produce a good or service at a lower
opportunity cost than competitors
 Absolute Advantage – Ability of an economic agent
to produce more of a good or service using the same
amount of resources.
 Specialization and gains from trade are based off of
comparative advantage, not absolute advantage.
Comparative Advantage & Int’l Trade
 Output per Hour Worked
Cell Phones
Japan
U.S.
Computers
12
6
2
4
Comparative Advantage & Int’l Trade
 Opportunity Cost of making each good.
Cell Phones
Japan
U.S.
Computers
1/2 Computer 2 Cell Phones
1/2 Cell
2 Computers Phones
Comparative Advantage & Int’l Trade
 Production and Consumption with a 1,000 hours of
labor in autarky (i.e. no trade).


750 hours of production towards Cell Phones
250 hours of production towards Computers
Cell Phones Computers
Japan
9,000
1,500
U.S.
1,500
1,000
Increasing Consumption Through Trade
 Terms of trade - the rate of exchange of one good or
service for another when two countries trade with
each other.
 In our example, the terms of trade will be one cell
phone for one computer.
Increasing Consumption Through Trade
 Before we trade, lets specialize based on
Comparative Advantage.
Cell Phones
Japan
U.S.
Computers
12,000
0
0
4,000
Increasing Consumption Through Trade
 Now trade 1,500 cell phones for 1,500 computers.
Cell Phones
Japan
U.S.
Computers
10,500
1,500
1,500
2,500
Increasing Consumption Through Trade
 Compared to autarky, Japan gained 1,500 cell
phones and the U.S. gained 1,500 computers.
 The increase in each countries PPF simply came
about through specialization based off of
Comparative Advantage and Trade. Both countries
increased their consumption without having to
increase the F.o.P. or implement new technology.
Why Don’t We See Complete Specialization?
 Not all goods can be traded internationally (e.g.
haircuts, tattoos, appendectomies).
 Production of most goods involves increasing
opportunity costs. As one country increases its
production of a good, the opportunity cost may rise
to the level of the opportunity cost of the other
country, stopping short of complete specialization.
Where Does Comparative Advantage Come
From?
 Climate and Natural Resource.
 Saudi Arabia has a comparative advantage in oil.
 Costa Rica has a comparative advantage in bananas.
 U.S. has a comparative advantage in wheat.
 Iowa has a comparative advantage in corn and pork.
Where Does Comparative Advantage Come
From?
 Relative Abundance of Labor and Capital
 U.S. has a relative abundance of skilled workers and
sophisticated capital and therefore manufactures aircrafts,
semiconductors, and computer software.
 China has a relative abundance of unskilled workers and basic
capital. They manufacture tools, clothing, and toys.
Where Does Comparative Advantage Come
From?
 Technology
 Product Technology – technology to develop new products.


U.S. was one of the first countries to produce radios, televisions,
computers, and automobiles
Process Technology – technology to improve existing products.

Japan capitalized on the production of the above goods with
process technology and gained the comparative advantage in
producing them.
Where Does Comparative Advantage Come
From?
 External Economies – reduction in a firms costs that
results from an increase in the size of an industry.

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Southern California has a comparative advantage in the
production of movies
NYC has a comparative advantage in financial services
Dalton, GA has a comparative advantage in the production of
carpets.
Switzerland has a comparative advantage in precision
engineered watches.
Analyzing Trade
 Using Consumer, Producer, and Social Surplus to
analyze international trade.
 Trade creates a net benefit. Trade makes some
people better off and some worse off, but typically
the gains offset the losses.
Government Policies that Restrict Trade
 Tariff – taxes on imports.
 Quota – a numerical limit in the quantity of a
product that can be imported.
Protectionism
 Some people are against free trade and promote
policies that shield domestic firms from competition.

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Savings jobs
Protecting high wages
Protecting infant industries
Protecting national security
Health and safety concerns
Opposing low labor standards and child labor
Protecting culture
High Cost of Protectionism
 How much does it cost to protect a job? An average of
$231,289, figured across just 20 of the many protected
industries. Costs range from $132,870 per job saved in
the costume jewelry business to $1,376,435 in the
benzenoid chemical industry. Protectionism costs U.S.
consumers nearly $100 billion annually. It increases not
just the cost of the protected items but downstream
products as well. Protecting sugar raises candy and soft
drink prices; protecting lumber raises home-building
costs; protecting steel makes car prices higher; and so
forth.
 The Fruits of Free Trade. Federal Reserve Bank of Dallas, 2002 Annual Report
 http://www.dallasfed.org/assets/documents/fed/annual/2002/ar02.pdf
 Primary Source: G. C. Hufbauer and K. A. Elliott, Measuring the Costs of Protection in the
United States, (Washington, D.C.: Institute for International Economics, 1994), pp. 11–13.