2. Chapter Objectives
• Comparative advantage and the
gains from trade
• Exports and imports
• Economic effects of tariffs and
quotas
• Arguments for protectionism
37-2
3. Some Key Facts
• U.S. trade deficit in goods
–$815 billion in 2007
• U.S. trade surplus in services
–$107 billion in 2007
• Canada largest U.S. trade partner
• Trade deficit with China
–$257 billion in 2007
• Exports are 12% U.S. output
• Dependence on oil 37-3
5. Economic Basis for Trade
• Nations have different resource
endowments
• Labor-intensive goods
• Land-intensive goods
• Capital-intensive goods
37-5
6. Comparative Advantage
• Assumptions
–Two nations
–Same size labor force
–Constant costs in each country
–Different costs across countries
–U.S. absolute advantage in both
• Opportunity cost ratio
–Slope of the curve
–Coffee sacrificed per ton of wheat
37-6
8. • Self-sufficiency output mix
• Specialization and trade
• Produce good with lowest
domestic opportunity cost
• Opportunity cost 1 ton wheat
–1 pound of coffee in U.S.
–2 pounds of coffee in Brazil
Comparative Advantage
37-8
9. • Terms of trade
–U.S. 1W = 1C
–U.S. will sell 1W for more than 1C
–Brazil 1W = 2C
–Brazil will pay less than 2C for 1W
–Settle between the two
–Depends on supply/demand factors
–Assume 1W = 1.5C
Comparative Advantage
37-9
10. • Gains from trade
–Trade possibilities line
–Slope equals terms of trade
–Improved options
• Complete specialization
• More of both goods
• More efficient resource allocation
Comparative Advantage
37-10
11. Economic Basis for Trade
Coffee(Tons)
30
25
20
15
10
5
0
35
40
45
5 10 15 20 25 30
Wheat (Tons)
Coffee(Tons)
30
25
20
15
10
5
0
35
40
45
5 10 15 20
Wheat (Tons)
(a) United States (b) Brazil
12
18 8
4
A
B
A’
B’
C
C’
W
c
w w’
Trading
Possibilities Line
Trading
Possibilities Line
37-11
12. Comparative Advantage
• Trade with increasing costs
–Concave production curve
–Resources not perfectly
substitutable
–Incomplete specialization
• The case for free trade
–Promote efficiency
–Promote competition
37-12
13. Supply and Demand Analysis
• World price
• Domestic price with no trade
• World price > domestic price
–Export surplus
–Export supply curve
• World price < domestic price
–Import shortage
–Import supply curve
37-13
14. Price(PerPound;U.S.Dollars
1.50
1.25
1.00
.75
.50
0
50 75 100 125 150
Quantity of Aluminum
(Millions of Pounds)
1.50
1.25
1.00
.75
.50
0
50 100
Quantity of Aluminum
(Millions of Pounds)
Price(PerPound;U.S.Dollars
(a) U.S. Domestic
Aluminum Market
(b) U.S. Export Supply
and Import Demand
Dd
Sd
U.S.
Export
Supply
U.S.
Import
Demand
a
b
c
x
y
Surplus = 50
Surplus = 100
Shortage = 50
Shortage = 100
Supply and Demand Analysis
37-14
15. Supply and Demand Analysis
Price(PerPound;U.S.Dollars
1.50
1.25
1.00
.75
.50
0
50 75 100 125 150
Quantity of Aluminum
(Millions of Pounds)
1.50
1.25
1.00
.75
.50
0
50 100
Quantity of Aluminum
(Millions of Pounds)
Price(PerPound;U.S.Dollars
(a) Canada’s Domestic
Aluminum Market
(b) Canada’s Export Supply
and Import Demand
Dd
Sd
Canadian
Export
Supply
Canadian
Import
Demand
q
r
s
t
Surplus = 50
Surplus = 100
Shortage = 50
37-15
16. International Equilibrium
1.00
.75
.88
0
50 100
Quantity of Aluminum
(Millions of Pounds)
Price(PerPound;U.S.Dollars
Import demand = Export supply
Canadian
Export
Supply
Canadian
Import Demand
e
U.S.
Export
Supply
U.S.
Import
Demand
Equilibrium
37-16
18. Trade Barriers
• Economic impact of tariffs
• Direct effects
–Decline in domestic consumption
–Increase in domestic production
–Decline in imports
–Tariff revenue
• Indirect effects
37-18
20. The Case for Protection
• Different arguments
• Military self-sufficiency
• Diversification for stability
• Infant industry
• Protection against dumping
• Increased domestic employment
• Cheap foreign labor
37-20
21. The WTO Protests
• World Trade Organization has
151 member nations
–Liberalize trade through negotiation
• Protest groups
–Labor unions, environmentalists,
socialists, anarchists
• Key issues for the protestors
–Labor protection and environmental
standards
37-21
