Principles of Economics Chapter 33 PDF

Principles of Economics Thirteenth Edition Chapter 33 International Trade, Comparative Advantage, and Protectionism Copyright © 2020, 2016, 2011 Pearson E...

Principles of Economics Thirteenth Edition Chapter 33 International Trade, Comparative Advantage, and Protectionism Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Trade Surpluses and Deficits trade surplus The situation when a country exports more than it imports. trade deficit The situation when a country imports more than it exports. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Economic Basis for Trade: Comparative Advantage Corn Laws The tariffs, subsidies, and restrictions enacted by the British Parliament in the early 19th century to discourage imports and encourage exports of grain. theory of comparative advantage 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. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Absolute Advantage versus Comparative Advantage absolute advantage The advantage in the production of a good enjoyed by one country over another when it uses fewer resources to produce that good than the other country does. comparative advantage The advantage in the production of a good enjoyed by one country over another when that good can be produced at a lower opportunity cost (in terms of other goods that must be forgone) than it could be in the other country. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Gains from Mutual Absolute Advantage (1 of 2) Table 33.1 Yield per Acre of Wheat and Cotton Blank New Zealand Australia Wheat 6 bushels 2 bushels Cotton 2 bales 6 bales In this case, the two countries have mutual absolute advantage Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Gains from Mutual Absolute Advantage (2 of 2) Table 33.2 Total Production of Wheat and Cotton Assuming No Trade, Mutual Absolute Advantage, and 100 Available Acres Blank New Zealand Australia 25 acres × 6 bushels/acre = 150 bushels 75 acres × 2 bushels/acre = 150 bushels 25 acres times 6 bushels per acre equals 150 bushels. 75 acres times 2 bushels per acre equals 150 bushels. Wheat 75 acres × 2 bales/acre = 150 bales 25 acres × 6 bales/acre = 150 bales 75 acres times 2 bales per acre equals 150 bales. 25 acres times 6 bales per acre equals 150 bales. Cotton When both countries have an absolute advantage in the production of one product, it is easy to see that specialization and trade will benefit both. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 33.1 Production Possibility Frontiers for Australia and New Zealand Before Trade Without trade, countries are constrained by their own resources and productivity. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 33.3 Production and Consumption of Wheat and Cotton After Specialization The advantages of specialization and trade seem obvious when one country is technologically superior at producing one product and another country is technologically superior at producing another product. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 33.2 Expanded Possibilities after Trade Trade enables both countries to move beyond their own resource constraints—beyond their individual production possibility frontiers. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Gains from Comparative Advantage Table 33.4 Yield per Acre of Wheat and Cotton Blank New Zealand Australia Wheat 6 bushels 1 bushel Cotton 6 bales 3 bales Now New Zealand has a considerable absolute advantage in the production of both cotton and wheat. Ricardo would argue that specialization and trade are still mutually beneficial. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 33.5 Total Production of Wheat and Cotton Assuming No Trade and 100 Available Acres Blank New Zealand Australia 50 acres × 6 bushels/acre = 300 bushels 75 acres × 1 bushel/acre = 75bushels 50 acres times 6 bushels per acre equals 300 bushels. 75 acres times 1 bushels per acre equals 75 bushels. Wheat 50 acres × 6 bales/acre = 300 bales 25 acres × 3 bales/acre = 75 bales 50 acres times 6 bales per acre equals 300 bales. 25 acres times 3 bales per acre equals 75 bales. Cotton Before any trade takes place, each country is constrained by its own domestic production possibility curve. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 33.6 Realizing a Gain from Trade When One Country Has a Double Absolute Advantage For Ricardo to be correct, it must be true that moving resources around in the two countries generates more than the 375 bushels of wheat and bales of cotton that we had before specialization. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Why Does Ricardo’s Plan Work? Figure 33.3 Comparative Advantage Means Lower Opportunity Cost The real cost of cotton is the wheat sacrificed to obtain it. The cost of 3 bales of cotton in New Zealand is 3 bushels of wheat (a half acre of land must be transferred from wheat to cotton—refer to Table 33.4). However, the cost of 3 bales of cotton in Australia is only 1 bushel of wheat. Australia has a comparative advantage over New Zealand in cotton production, and New Zealand has a comparative advantage over Australia in wheat production. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Terms of Trade terms of trade The ratio at which a country can trade domestic products for imported products. The terms of trade determine how the gains from trade are distributed among trading partners. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Exchange Rates (1 of 2) Trade in international markets happens with money instead of barter. exchange rate The ratio at which two currencies are traded. The price of one currency in terms of another. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Trade and Exchange Rates in a Two- Country/Two-Good World Table 33.7 Domestic Prices of Timber (per Foot) and Rolled Steel (per Ton) in the United States and Brazil Blank United States Brazil Timber $1 3 Reals Rolled steel $2 4 Reals Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Table 33.8 Trade Flows Determined by Exchange Rates Exchange Price of Result Rate Real $1 = 1 R $1.00 Dollar 1 point 0 0 Brazil imports timber and steel. $1 = 2 R $0.50 Brazil imports timber $1 = 2.1 R $0.48 Brazil imports timber; United States imports steel. $1 = 2.9 R $0.34 Brazil imports timber; United States imports steel. $1 = 3 R $0.33 United States imports steel. $1 = 4 R $0.25 United States imports timber and steel. Trade flows in both directions as long as the exchange rate settles between $1 = 2 R and $1 = 3 R. Stated the other way around, trade will flow in both directions if the price of a real is between $0.33 and $0.50. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Exchange Rates (2 of 2) Exchange Rates and Comparative Advantage 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 enjoys a comparative advantage. Only in a country with a comparative advantage will those products be competitive in world markets. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Sources of Comparative Advantage factor endowments The quantity and quality of labor, land, and natural resources of a country. The Heckscher-Ohlin Theorem Heckscher-Ohlin theorem A theory that 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. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Other Explanations for Observed Trade Flows Comparative advantage does not explain why many countries import and export the same kinds of goods. Product differentiation is a natural response to diverse preferences across economies. Some economists distinguish between gains from acquired comparative advantages and gains from natural comparative advantages. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Trade Barriers: Tariffs, Export Subsidies, and Quotas protection The practice of shielding a sector of the economy from foreign competition. tariff A tax on imports. export subsidies Government payments made to domestic firms to encourage exports. dumping A firm’s or an industry’s sale of products on the world market at prices below its own cost of production. quota A limit on the quantity of imports. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Free Trade or Protection? The Case for Free Trade In one sense, the theory of comparative advantage is the case for free trade. Citizens in both countries involved in trade end up paying less and consuming more. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 33.4 The Gains from Trade and Losses from the Imposition of a Tariff A tariff of $1 increases the market price facing consumers from $2 per yard to $3 per yard. The government collects revenues equal to the gray shaded area in panel (b). The loss of efficiency has two components. First, consumers must pay a higher price for goods that could be produced at lower cost. Second, marginal producers are drawn into textiles and away from other goods, resulting in inefficient domestic production. The triangle labeled ABC in panel (b) is the deadweight loss or excess burden resulting from the tariff. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Case for Protection (1 of 4) Protection Saves Jobs Foreign competition costs Americans their jobs. Victims of free trade can be aided constructively without forgoing the gains from trade. Some Countries Engage in Unfair Trade Practices Free trade may be the best solution when everybody plays by the rules. The WTO is the vehicle currently used to negotiate disputes involving unfair trade practices. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Case for Protection (2 of 4) Cheap Foreign Labor Makes Competition Unfair Wages in a competitive economy reflect productivity, and trade flows according to comparative, not absolute, advantage: All countries benefit, even if one country is more efficient at producing everything. Protection Safeguards National Security Even if we acknowledge another country’s comparative advantage, we may want to protect our own resources. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Case for Protection (3 of 4) Protection Discourages Dependency Protecting industries in areas where a country has a comparative disadvantage may prevent trading relationships that might lead to political dependence. Environmental Concerns Some environmental groups argue that free trade policies may harm the environment and that by imposing penalties on high-polluting products, the prices of goods imported this way would reflect the harm that those products cause. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved The Case for Protection (4 of 4) Protection Safeguards Infant Industries infant industry A young industry that may need temporary protection from competition from the established industries of other countries to develop an acquired comparative advantage. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Figure 33.5 Trade Openness across the World (Index is 100 Minus the Average Effective Tariff Rate in the Region.) The case for free trade has been made across the world as increasing numbers of countries have joined the world marketplace. This figure traces the path of tariffs across the world from 1980 to 2005. The lines show an index of trade openness, calculated as 100 minus the tariff rate. (So higher numbers mean lower tariffs.) We see rapid reductions in the last 25 years across the world, most notably in countries in the emerging and developing markets. Source: International Monetary Fund, 2007 World Economic Outlook. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved An Economic Consensus According to the theory of comparative advantage, all countries benefit from specialization and trade: Free international trade raises real incomes and improves the standard of living. Although protectionists argue for the protection of workers from foreign competition, it is unlikely to cause net job loss in an economy as workers are absorbed into expanding sectors over time. Foreign trade and full employment can be pursued simultaneously. Although economists disagree about many things, the vast majority of them favor free trade. Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved Review Terms and Concepts absolute advantage North American Free Trade comparative advantage Agreement (NAFTA) Corn Laws protection Doha Development Agenda quota dumping Smoot-Hawley tariff economic integration tariff European Union (EU) terms of trade exchange rate theory of comparative advantage export subsidies trade deficit factor endowments trade surplus General Agreement on Tariffs and U.S.–Canadian Free Trade Trade (GATT) Agreement Heckscher-Ohlin theorem World Trade Organization (WTO) infant industry Copyright © 2020, 2016, 2011 Pearson Education, Inc. 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