Chapter 27 International Trade

History: Civil War, Anaconda Plan used to block Confederacy from trading its cotton with Britain
-benefits of trading, cotton sold 10 to 20 times more than in Confederacy
NAFTA (North American Free Trade Agreement)
-opposition due to costing American jobs
Comparative Advantage: Nations specialize in product with comparative advantage, then trade freely
Effects of Trade Restrictions
Comparative Advantage as a Basis for Trade
-specialization based on comparative advantage, with trade between producers of different goods
and services
+higher level of productivity and standard of living
-principle of comparative advantage: enjoy more goods and services when each country produces
according to comparative advantage and trade with each other
Production and Consumption Possibilities and the Benefits of Trade
Close economy: does not trade with the rest of the world
Open economy: trades with other economies
PPC: smoothly-bowed shape, slope of PPC = OC of producing an additional good, more of one good
produce = higher OC
Consumption Possibilities with and without International Trade
Consumption Possibilities: combinations of goods and services that countrys citizens might consume
-closed economy with no trade = societys consumption possibilities are identical to production
possibilities (autarky)
-open economy with trade = societys consumption possibilities greater than production possibilities
+trade allows conversion of one good to money to purchase another good -> more of another
good than PPF
+CPC tangent to PPC has slope = ratio of Px/Py, the amount of goodY needed to be traded to
get one unit of goodX
+at tangent point, OC increasing Good X = OC purchasing extra Good Y, largest total revenue
World Prices Affecting Nations Production
Case Study: Nation can produce equal amounts of coffee and tea in one day (800 pounds)
-If Price of Coffee = 2 Price of Tea, country will produce as much coffee as possible and no tea
+this will cause CPC to extend the amount of Tea with trading
-If Price of Coffee = Price of Tea, country will produce as much tea as possible and no coffee
+this will cause CPC to extend the amount of Coffee with trading
A country maximizes its consumption possibilities by producing at the point where CPC is
tangent to PPC, then trading to reach preferred point on CPC
Cheap foreign labor posing danger to high-wage economies
-argument: high-wage industrialized countries lose by trading with low-wage developing nations

-principle of comparative advantage and specialization advantages

-low wages = low productivity of labor, thus less productive than developed nations
-nations gain by one nation specializing under comparative advantage
A Supply and Demand Perspective on Trade
Add to the supply and demand curve, the world price line:
-If the price of a good in a closed economy > world price, and the economy opens to
trade, the economy will tend to become a net importer of that good
+consumer surplus increases by triangular area between, supply demand and world price
lines
+producer surplus decreases by area defined between original P *, supply curve, and world
price
-If the price of a good in a closed economy < world price, and that economy opens to
trade, the economy will tend to become a net exporter of that good
+producer surplus increases by triangular area between, supply demand and world price lines
+consumer surplus decreases by area between original P *, demand curve, and world price
Winners and Losers from Trade
-if groups who are hurt by trade have sufficient political influence, they may persuade politicians to enact
policies to restrict trade
-domestic consumers of imported goods benefit from free trade
-domestic producers of imported goods are hurt by free trade
-domestic producers of exported goods benefit from free trade
-domestic consumers of exported goods are hurt by free trade
-free trade is efficient, increases total economic surplus to economy
Protectionist Policies: Tariffs and Quotas
Protectionism: the view that free trade is injurious and should be restricted
Tariff: tax imposed on an imported good
-Case Study: Costa Rican computer makers convince government to create tariff on imported
computers to country
+World Price is elevated to World Price + Tariff
+Consumers pay the world price + tariff price, pay more than original world price
+Producers will be able to raise the price they charge to world price + tariff, increase
production
+Total economic surplus decreases by area between world price + tariff, world price, supply,
and demand
-Domestic producers suffer losses such that they are willing to gain political support to impose
tariffs on import
Quotas: legal limit on the number of foreign goods that can be imported
-require importers to obtain a license for each good they bring to country, government then
distributes exactly same numbers of permits as number of goods that may be imported

-same effect as elevating world price like tariff

+quantity supplied in market = production of domestic firms plus quota of imported goods
+shifts supply curve such hat new supply curve = domestic supply curve + quota
-all prices above world price, quantity is shifted so that new curve reflects addition of
quota
+domestic demand curve remains the same
+equilibrium point at supply curve including quota and demand curve intersection
-raises the domestic price of good
-reduces domestic purchase of good
-increases domestic production of good
-reduces imports
-consumer and producer surplus the same as would under a tariff
-while tariff generates government revenue, the supposed revenue under quota = economic rent for
people with license
+licensed firms may purchase good at world price and resell at higher price, thus economic
rent
The Inefficiency of Protectionism
-free trade is efficient: specialization in production to greatest comparative advantage
-protectionist policies reduce total economic surplus
-winners of free trade can compensate the losers such that everyone is better off
+worker assist and retraining programs
+environmental problems
Outsourcing: having services performed by low wage workers overseas