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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

International Trade, International Trade, Comparative Advantage, and Comparative Advantage, and

ProtectionismProtectionism


International TradeInternational Trade

• All economies, regardless of their size, All economies, regardless of their size, depend to some extent on other depend to some extent on other economies and are affected by events economies and are affected by events outside their borders.outside their borders.

• The “internationalization” or “globalization” The “internationalization” or “globalization” of the U.S. economy has occurred in the of the U.S. economy has occurred in the private and public sectors, in input and private and public sectors, in input and output markets, and in business firms and output markets, and in business firms and households.households.


Absolute Advantage Versus Absolute Advantage Versus Comparative AdvantageComparative Advantage

• A country enjoys an A country enjoys an absolute advantageabsolute advantage over another country in the production of a over another country in the production of a product if it uses fewer resources to produce product if it uses fewer resources to produce that product than the other country does.that product than the other country does.

• A country enjoys a A country enjoys a comparative advantagecomparative advantage in the production of a good if that good can in the production of a good if that good can be produced at a lower cost be produced at a lower cost in terms of in terms of other goodsother goods..


Gains from Comparative AdvantageGains from Comparative Advantage

• Even if a country had a considerable Even if a country had a considerable absolute advantage in the production of absolute advantage in the production of both goods, Ricardo would argue that both goods, Ricardo would argue that specialization and trade are still mutually specialization and trade are still mutually beneficialbeneficial..

• When countries specialize in producing the When countries specialize in producing the goods in which they have a comparative goods in which they have a comparative advantage, they maximize their combined advantage, they maximize their combined output and allocate their resources more output and allocate their resources more efficiently.efficiently.


Exchange RatesExchange Rates

• When trade is free—unimpeded by When trade is free—unimpeded by government-instituted barriers—patterns of government-instituted barriers—patterns of trade and trade flows result from the trade and trade flows result from the independent decisions of thousands of independent decisions of thousands of importers and exporters and millions of importers and exporters and millions of private households and firms.private households and firms.

• To understand these patterns we must To understand these patterns we must know something about the factors that know something about the factors that determine exchange rates.determine exchange rates.


Exchange RatesExchange Rates

• An An exchange rateexchange rate is the ratio at which two is the ratio at which two currencies are traded. The price of one currencies are traded. The price of one currency in terms of another.currency in terms of another.

• For any pair of countries, there is a range of For any pair of countries, there is a range of exchange rates that can lead automatically exchange rates that can lead automatically to both countries realizing the gains from to both countries realizing the gains from specialization and comparative advantage.specialization and comparative advantage.

• Exchange rates determine the terms of Exchange rates determine the terms of trade.trade.


The Sources ofThe Sources ofComparative AdvantageComparative Advantage

• Factor endowmentsFactor endowments refer to the quantity refer to the quantity and quality of labor, land, and natural and quality of labor, land, and natural resources of a country.resources of a country.

• Factor endowments seem to explain a Factor endowments seem to explain a significant portion of actual world trade significant portion of actual world trade patterns.patterns.


Trade Barriers: Tariffs,Trade Barriers: Tariffs,Export Subsidies, and QuotasExport Subsidies, and Quotas

• ProtectionProtection is the practice of shielding a is the practice of shielding a sector of the economy from foreign sector of the economy from foreign competition.competition.

• A A tarifftariff is a tax on imports. is a tax on imports.

• Export subsidiesExport subsidies are government payments are government payments made to domestic firms to encourage exports. made to domestic firms to encourage exports. Closely related to subsidies is Closely related to subsidies is dumpingdumping. A . A firm or industry sells products on the world firm or industry sells products on the world market at prices below the cost of production.market at prices below the cost of production.

• A A quotaquota is a limit on the quantity of imports. is a limit on the quantity of imports.


The Case for Free TradeThe Case for Free Trade

• The case for free trade is based on the The case for free trade is based on the theory of comparative advantage. When theory of comparative advantage. When countries specialize and trade based on countries specialize and trade based on comparative advantage, consumers pay comparative advantage, consumers pay less and consume more, and resources less and consume more, and resources are used more efficiently.are used more efficiently.

• When tariffs and quotas are imposed, When tariffs and quotas are imposed, some of the gains from trade are lost.some of the gains from trade are lost.


The Case for ProtectionThe Case for Protection

• Protection saves jobsProtection saves jobs

• Some countries engage in unfair trade Some countries engage in unfair trade practicespractices

• Cheap foreign labor makes competition Cheap foreign labor makes competition unfairunfair

• Protection safeguards national securityProtection safeguards national security

• Protection discourages dependencyProtection discourages dependency

• Protection safeguards infant industriesProtection safeguards infant industries