International Trade, Comparative
Advantage, and Protectionism
z A trade surplus exists when a country exports
more than it imports.
z A trade deficit exists when a country imports
more than it exports.
Chapter 20
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Canada’s Major Exports and Imports
in 1999 (Table 20.1)
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Trade Surpluses and Deficits
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Canada’s Balance of Trade, 19461999 (millions of dollars) Table 20.2
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Corn Laws
Theory of Comparative Advantage
z The tariffs, subsidies, and restrictions enacted
by British parliament in the early nineteenth
century to discourage imports and encourage
exports of grain.
z Ricardo’s theory that specialization and free
trade will benefit all trading partners (real
wages will rise), even those that may be
absolutely less efficient producers.
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Absolute Advantage
Comparative Advantage
z A country has an absolute advantage in the
production of a good if it can produce more of
the good with a fixed amount of resources than
can any other country. (i.e. when the country
uses fewer resources to produce a product than
the other country)
z Comparative advantage is the advantage in the
production of a product enjoyed by one country
over another when that product can be
produced at a lower opportunity cost.
z The opportunity cost of a product is the
alternative products that must be sacrificed to
facilitate its production.
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Australia and New Zealand:
An Example (from Table 20.3)
z Yield per hectare of wheat and cotton:
z New Zealand
y 6 tonnes wheat
y 2 bales cotton
z Australia
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Mutual Absolute Advantage
z In this example Australia has the absolute
advantage in producing cotton and New Zealand
the absolute advantage in producing wheat. In
cases like this the countries are said to have a
mutual absolute advantage.
y 2 tonnes wheat
y 6 bales cotton
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Australia and New Zealand:
An Example (from Table 20.4)
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Production Possibilities of Australia and
New Zealand Before Trade (Figure 20.1)
z Total production of wheat and cotton assuming no
trade, mutual absolute advantage, and 100 hectares
available
y New Zealand
x Wheat: 25 hectares x 6 tonnes/hectare = 150 tonnes
x Cotton: 75 hectares x 2 bales/hectare = 150 bales
y Australia
x Wheat: 75 hectares x 2 tonnes/hectare = 150 tonnes
x Cotton: 25 hectares x 6 tonnes/hectare = 150 tonnes
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Advantages of Trade and
Specialization
Production and Consumption of Wheat
and Cotton After Specialization (Table 20.5)
z Both countries are initially restricted to their
own PPF which represents all the combinations
of goods that can be produced given the
countries’ resources and state of technology.
z After trade both countries are able to move out
beyond their previous resource and productivity
constraints.
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Expanded Possibilities After Trade
(Figure 20.2)
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Gains from Trade When One Country Has an
Absolute Advantage in Both Goods (Tables 20.6 and 20.7)
z Yield per Hectare of Wheat and Cotton
z Total Production of Wheat and Cotton Before Trade (100
hectares)
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Realizing a Gain From Trade When One
Country Has a Double Absolute Advantage
(Table 20.8)
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Comparative Advantage Means
Lower Opportunity Cost (Figure 20.3)
When countries specialize in producing those goods in which they have a
comparative advantage, they maximize their combined output and
allocate resources more efficiently.
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Terms of Trade
Exchange Rates
z The terms of trade refers to the ratio at which a
country can trade domestic products for
imported products.
z The price of one country’s currency in terms of
another country’s currency. The ratio at which
two currencies are traded
z For any pair of countries, and given domestic
prices, there is a range of exchange rates that
can lead automatically to both countries
realizing the gains from specialization and
comparative advantage
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Trade and Exchange Rates in a Two
Country / Two Good World (from Table 20.9)
z Domestic Prices of Lumber and Cloth in Canada
and the United States
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Canadian-Dollar Prices of Lumber and Cloth in
Canada and the United States If C$1=US$0.50
(from Table 20.10)
y Canada
x Lumber: C$5/metre
x Cloth: C$5/metre
y United States
y Canada
x Lumber: US$4/metre = C$8/metre
x Cloth: US$3/metre = C$6/metre
x Cloth: C$5/metre
x Lumber: C$5/metre
y United States
y Since both products are cheaper in Canada, no
Canadian will purchase US products but Americans
will import both products from Canada.
x Cloth: US$4/metre
x Lumber: US$3/metre
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Canadian-Dollar Prices of Lumber and Cloth in
Canada and the United States If C$1=US$1
(from Table 20.11)
y Canada
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Canadian-Dollar Prices of Lumber and Cloth in
Canada and the United States If C$1=US$0.80
(from Table 20.12)
y Canada
x Lumber: C$5/metre
x Cloth: C$5/metre
x Lumber: C$5/metre
x Cloth: C$5/metre
y United States
y United States
x Lumber: US$4/metre = C$4/metre
x Cloth: US$3/metre = C$3/metre
y Americans will have no interest in Canadian products
but Canadians will convert dollars to purchase
(import) both products from the U.S.
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x Lumber: US$4/metre = C$5/metre
x Cloth: US$3/metre = C$3.75/metre
y Americans will have no interest in Canadian products
but Canadians will convert dollars to purchase
(import) cloth from the U.S.
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Canadian-Dollar Prices of Lumber and Cloth in
Canada and the United States If C$1=US$0.75
Trade Flows Determined By
Exchange Rates (Table 20.13)
y Canada
x Lumber: C$5/metre
x Cloth: C$5/metre
y United States
x Lumber: US$4/metre = C$5.33/metre
x Cloth: US$3/metre = C$4.00/metre
y Americans will wish to purchase Canadian lumber and
Canadians will convert dollars to purchase (import)
cloth from the U.S.
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z If exchange rates end up in the right ranges, the free
market will drive each country to shift resources into those
sectors in which it has a comparative advantage. Only those
products in which a country has a comparative advantage
will be competitive on world markets.
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Sources of Comparative Advantage
Heckscher-Ohlin Theorem
z Factor endowments (Heckscher-Ohlin Theorem)
z The H-O Theorem explains the existence of a
country’s comparative advantage by its factor
endowments: A country has a comparative
advantage in the production of a product if that
country is relatively well endowed with inputs
used intensively in the production of that
product.
y The quantity and quality of labour, land and natural
resources of a country.
z Product differentiation
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Trade Barriers
Dumping
z Protection: The practice of shielding a sector of
the economy from foreign competition.
z Tariffs: A tax on imports.
z Export Subsidies: Government payments made
to domestic firms to encourage exports.
z Quotas: A limit on the quantity of imports.
z Dumping is when a firm or an industry sells
products on the world market at prices below
the cost of production.
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General Agreement on Tariffs and
Trade (GATT)
Smoot-Hawley Tariff
z The U.S. tariff law of the 1930’s that set the
highest tariffs in US history (60%). It set off an
international trade war and caused a decline in
trade that is often considered a cause of the
worldwide depression of the 1930’s.
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z The GATT is an international agreement signed
by the Canada and 22 other countries in 1947 to
promote the liberalization of foreign trade.
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World Trade Organization
European Union (EU)
z The body currently responsible for governing
world trade.
z The WTO replaced the General Agreement on
Tariffs and Trade (GATT) on January 1, 1995.
z The EU is the European trading bloc composed
of Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Ireland, Italy, Luxembourg,
the Netherlands, Portugal, Spain, Sweden, and
the United Kingdom.
z The EU is an example of economic integration
which occurs when two or more countries join
to form a free trade zone.
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Canada-US Free-Trade Agreement
z An agreement which came into effect January 1,
1989, in which Canada and the United States
agreed to eliminate all barriers to trade between
the two countries over a ten-year period.
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North American Free-Trade
Agreement (NAFTA)
z An agreement, which came into effect on
January 1, 1994, signed by Canada, the United
States, and Mexico, in which the three countries
agreed to establish all of North America as a
free trade zone.
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The Gains From Trade
(Figure 20.4a)
Losses from the Imposition of a
Tariff (Figure 20.4b)
z Foreign producers are
able to provide textiles
on the world market
much cheaper than
Canadian producers.
z Trade lowers the price
for Canadian consumers
and allocates resources
into industries in which
Canada has the
comparative advantage.
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The Case for Protection
z
z
z
z
z
z
Saves jobs
Unfair trade practices by other countries
Cheap foreign labour
Safeguard national security
Discourages dependency
Safeguard infant industries
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z A tariff of $1 per metre
increases the market
price. The government
collects the tariff
revenue.
z Loss of efficiency
occurs because:
y Consumers pay a higher
price
y Inefficient producers are
drawn into domestic
textile production.
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Review Terms & Concepts
z absolute advantage
z Canada-US Free Trade
Agreement
z comparative advantage
z Corn Laws
z dumping
z economic integration
z European Union
z exchange rate
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z
z
z
z
z
z
z
z
export subsidies
factor endowments
GATT
Heckscher-Ohlin Theorem
infant industry
NAFTA
protection
quota
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Review Terms & Concepts (cont.)
Smoot-Hawley tariff
tariff
terms of trade
theory of comparative
advantage
z trade deficit
z trade surplus
z World Trade Organization
z
z
z
z
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