Chapter 32

1. Chapter 32 Comparative Advantage and the Open Economy

2. Introduction In early 2010, President Barack Obama announced his intention to double U.S. exports of goods and services by 2015. Ironically, during the same week, a report documented barriers that the Chinese government had established to hinder U.S. exports from entering China. In this chapter, you will learn how nations can gain from both exporting and importing goods and services. You will also learn about tariffs and other mechanisms that governments often utilize to reduce imports.

3. Learning Objectives Discuss the worldwide importance of international trade Explain why nations can gain from specializing in production and engaging in international trade Understand common arguments against free trade

4. Learning Objectives (cont’d) Describe ways that nations restrict foreign trade Identify key international agreements and organizations that adjudicate trade disputes among nations

5. Chapter Outline The Worldwide Importance of International Trade Why We Trade: Comparative Advantage and Mutual Gains from Exchange The Relationship Between Imports and Exports International Competitiveness

6. Chapter Outline (cont’d) Arguments Against Free Trade Ways to Restrict Foreign Trade International Trade Organizations

7. Did You Know That ... Ford Motor Company produces small passenger vans in a factory located in Turkey and ships them to Baltimore, Maryland, where employees strip out the vehicles’ rear seats and replace their rear windows with metal panels? In this way, Ford sells the vehicles in the United States as commercial vans and it avoids a 25 percent tariff on imports of passenger vans. In this chapter, you will learn about the effects of import restrictions on quantities and prices of domestically produced goods and services.

8. The Worldwide Importance of International Trade World GDP today is nearly nine times greater than it was at the end of World War II World trade has increased to more than 28 times what it was in 1950

9. The Worldwide Importance of International Trade (cont'd) The United States has figured prominently in this expansion of world trade Imports added up to barely 4% of annual U.S. GDP in 1950 Today they account for almost 16%

10. Figure 32-1 The Growth of World Trade, Panel (a)

11. Figure 32-1 The Growth of World Trade, Panel (b)

12. Why We Trade: Comparative Advantage and Mutual Gains From Exchange We have learned about the concept of specialization and the mutual gains from trade We can understand gains from trade among nations by understanding output gains from specialization between individuals

13. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Scenario (8-hour day) Ad specialist 2 pages of ad copy/hour 1 art rendering/hour Computer artist 1 page of ad copy/hour 1 art rendering/hour

14. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Ad Specialist Computer Artist Total 12 4 hrs × 2 = 8 4 hrs × 1 = 4 8 4 hrs × 1 = 4 4 hrs × 1 = 4 Copy Renderings Without Trade (8-hour day)

15. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Ad Specialist Computer Artist Total 16 8 8 hrs × 2 = 16 Copy Renderings 8 hrs × 1 = 8 With Trade (8-hour day) Ad copy output increases by 4 pages per day

16. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Comparative Advantage The ability to produce a good or service at a lower opportunity cost compared with producers

17. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Specialization among nations To demonstrate the concept of comparative advantage, consider a simple two-country, two-good world

18. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Production and consumption capabilities in a two-country, two-good world We show maximum feasible quantities of software and PCs Using all resources—land, labor, capital, and entrepreneurship

19. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) U.S. residents can utilize all their resources to produce 90 units of software or 225 PCs per hour Residents of India are able to utilize all their resources to produce either 100 units of software or 50 PCs per hour

20. Table 32-1 Maximum Feasible Hourly Production Rates of Either Commercial Software or Personal Computers Using All Available Resources

21. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Comparative advantage The opportunity cost of producing a PC is lower in the United States than in India 1 PC = 0.4 units of software 1 unit of software = 2.5 PCs The opportunity cost of producing software is lower in India than the United States 1 PC = 2 units of software 1 unit of software = 0.5 PC

22. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Production without trade Table 32-2 tabulates two possible production choices “World” output is 55 units of software and 187.5 PCs (per hour)

23. Table 32-2 U.S. and Indian Production and Consumption Without Trade

24. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) The United States and India will specialize in activities with which they experience a lower opportunity cost In other words, they will specialize in the activity in which they have a comparative advantage

25. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Specialization in production United States will specialize Produce 225 PCs, and no software India will specialize Produce 100 software units, and no PCs

26. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Consumption with specialization and trade The United States is willing to buy 1 unit of Indian software as long as they provide in exchange no more than 2.5 PCs This is the United States’ opportunity cost of producing 1 unit of software at home

27. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Consumption with specialization and trade India buys a PC from the United States in exchange for no more than 2 units of software This is India’s opportunity cost of producing a PC at home

28. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Residents of the two nations agree to a rate of exchange of 1 PC for 1 unit of software Proceed to trade 75 U.S. PCs for 75 units of Indian software

29. Table 32-3 U.S. and Indian Production and Consumption with Specialization and Trade

30. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) By specializing and engaging in trade: The United States consumes 75 units of software imported from India and consumes 150 PCs produced at home Indian residents consume 25 units of software produced at home and import 75 PCs from the United States

31. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Gains from trade The United States’ gain from specialization and trade is 45 units of software India can consume 37.5 more PCs These are net gains

32. Table 32-4 National and Worldwide Gains from Specialization and Trade

33. International Example: Gains from International Trade in Used Merchandise Sofronis Clerides of the University of Cyprus has estimated the gains to residents of Cyprus from a decision by the Cypriot government to legalize imports of used Japanese cars. He finds that the typical buyer of a used imported vehicle realized a gain from trade of about $2,000.

34. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Specialization is the key Specializing in producing goods for which a nation has a comparative advantage allows for greater efficiency Production capabilities increase, making possible greater worldwide consumption through international trade

35. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Observations on specialization and trade Not everyone gains from trade Cannot “run out of exports” Every country will always have a comparative advantage in something

36. Why We Trade: Comparative Advantage and Mutual Gains From Exchange (cont'd) Other benefits from international trade: the transmission of ideas New goods, services spread New processes transmitted Intellectual property introduced

37. Figure 32-2 World Trade Flows

38. Why Not … obtain gains from trade by subsidizing exports and discouraging imports? Government subsidies for exports and policies induce domestic and foreign firms to specialize in production of items based on government incentives or disincentives rather than actual opportunity costs (comparative advantages). As a consequence, industries receive transfers from taxpayers, but society as a whole does not experience true gains from trade.

39. The Relationship Between Exports and Imports In the long run, imports are paid for by exports Any restrictions on imports ultimately reduce exports When a country engages in trade, it is not competing against the other countries All nations stand to benefit from trade

40. International Competitiveness Questions Is the United States falling behind? Do we need to stay competitive internationally? What does global competitiveness really mean?

41. International Competitiveness (cont'd) Answer The United States leads in overall productive efficiency, according to the Institute for Management Development in Lausanne, Switzerland

42. International Competitiveness (cont'd) Reasons for this ranking: Widespread entrepreneurship Economic restructuring Investment in information-technology Sophisticated financial system Large investments in scientific research

43. International Example: Can Africa’s International Competitiveness Be Improved? Despite abundant resources in the heart of Africa, most African railways and roads are in poor conditions, leading to high transportation costs and a long time in shipping containers. A French firm, Bolloré, is trying to improve Africa’s international competitiveness by creating “trade corridors” of riverways that can substantially reduce shipping times and costs.

44. Arguments Against Free Trade Infant Industry Argument The contention that tariffs should be imposed to protect from import competition an industry that is trying to get started Presumably, after the industry becomes technologically efficient, the tariff can be lifted

45. Arguments Against Free Trade (cont'd) Dumping Selling a good or a service abroad below the price charged in the home market or at a price below its cost of production

46. Arguments Against Free Trade (cont'd) Protecting domestic jobs Do imports reduce jobs? Gould/Woodbridge/Ruffin study – no casual link between the rate of imports and unemployment In half of the cases studied, when imports rose, unemployment fell

47. Arguments Against Free Trade (cont'd) The cost of protecting U.S. jobs Restrictions on textiles and apparel goods cost U.S. consumers $9 billion a year Cost $50,000 a year for each $20,000 job saved Restriction on imports of Japanese cars Cost $160,000 per year for each job saved in the auto industry

48. Arguments Against Free Trade (cont'd) The cost of protecting U.S. jobs Glass industry restrictions Cost $200,000 per year per job saved Steel industry restrictions Cost $750,000 per year per job saved

49. Arguments Against Free Trade (cont’d) Emerging arguments against free trade Environmental concerns Genetic engineering New diseases National defense Exports of new technology

50. Ways to Restrict Foreign Trade Quota System A government-imposed restriction on the quantity of a specific good that another country is allowed to sell in the United States In other words, quotas are restrictions on imports, usually applied to one or several specific countries