Chapter 22/International Trade and Comparative Advantage
CHAPTER 22
INTERNATIONAL TRADE AND COMPARATIVE
ADVANTAGE
This chapter introduces students to the principles of international trade. It outlines the Ricardian
doctrine of comparative advantage, showing that trade is to the advantage of both partners, even
if one is more efficient in the production of all goods. It also analyzes and evaluates
protectionism.
CHAPTER OUTLINE
WHY TRADE?
Countries benefit from foreign trade for many reasons:
1. They can import resources they lack at home.
2. They can import goods for which they are a relatively inefficient producer.
3. Specialization sometimes permits economies of large-scale production.
Mutual Gains from Trade
When trade is voluntary, both sides must expect to gain from it; otherwise they would not
trade.
INTERNATIONAL VERSUS INTRANATIONAL TRADE
International and intranational trade are similar in many respects.
We study international trade separately because:
1. Countries are governed by separate governments.
THE LAW OF COMPARATIVE ADVANTAGE
One country is said to have an absolute advantage over another in the production of a
particular good if it can produce that good using smaller quantities of resources than can the
other country.
One country is said to have a comparative advantage over another in the production of a
particular good relative to other goods if it produces that good less inefficiently as compared
with the other country.
Two countries can generally gain from trade, even if one of them is more efficient than the
other in producing everything.
Chapter 22/International Trade and Comparative Advantage
THE ARITHMETIC OF COMPARATIVE ADVANTAGE
A numerical example shows that, when countries differ in the relative efficiency with which
they produce different goods, both world output and the welfare of each country separately
The Graphics of Comparative Advantage
Production possibilities frontiers for two countries can show different opportunity costs and
the potential gains from trade.
A country’s absolute advantage in production over another country is shown by having a
higher per-capita production possibilities frontier. The difference in comparative advantages
between the two countries is shown by the difference in the slopes of their frontiers.
Must Specialization be Complete?
Specialization need not be complete because:
1. some countries are too small to provide the world’s entire output of a good.
ISSUE REVISITED: COMPARATIVE ADVANTAGE EXPOSES THE
“CHEAP FOREIGN LABOR” FALLACY
A country can benefit from trade, even if wages in the other country are considerably lower
than its own wages.
Nothing helps raise living standards more than a greater abundance of goods.
TARIFFS, QUOTAS, AND OTHER INTERFERENCES WITH TRADE
Countries can reduce imports by setting tariffs or quotas; they can promote exports by
subsidizing export goods.
A tariff is a tax on imports.
Chapter 22/International Trade and Comparative Advantage
Tariffs versus Quotas
When imports are to be reduced, tariffs are generally preferable to quotas because:
WHY INHIBIT TRADE?
Reasons why countries might restrict trade:
1. Gain a price advantage for domestic firms
2. Protect particular industries
CAN CHEAP IMPORTS HURT A COUNTRY?
Cheap imports are usually good for a country’s consumers.
Domestic producers may, however, be hurt.
A LAST LOOK AT THE “CHEAP FOREIGN LABOR” ARGUMENT
Labor is cheap in countries where productivity is low, and expensive in countries like the
APPENDIX: SUPPLY, DEMAND, AND PRICING IN WORLD TRADE
In a two-country supply-demand model without trade restrictions:
1. The price of a good must be the same in both countries.
How Tariffs and Quotas Work
Both tariffs and quotas normally have the effect of raising the price in the importing country,
reducing the price in the exporting country, and reducing the quantity of imports.
Chapter 22/International Trade and Comparative Advantage
MARGIN DEFINITIONS
Specialization: a country devotes its energies and resources to only a small proportion of the
world’s productive activities.
Absolute Advantage: a country can produce a good using smaller quantities of resources than
can another country.
Comparative Advantage: a country produces a good less inefficiently as compared with another
country.
Mercantilism: a doctrine that holds that exports are good for a country while imports are
harmful.
MAJOR IDEAS
1. Countries trade because differences in their natural resources and other inputs create
discrepancies in the efficiency with which they can produce different goods, and because
specialization may offer them greater economies of large-scale production.
2. Two countries will gain from trade with one another if each exports goods in which it has
a comparative advantage. Even a country that is inefficient across the board will benefit
by exporting the goods in whose production it is least inefficient.
3. When countries specialize and trade, each can enjoy consumption possibilities that
exceed its production possibilities.
4. Restrictions on trade generally raise the prices of goods for the importing country.
Chapter 22/International Trade and Comparative Advantage
7. Although the same trade restrictions can be accomplished by either a tariff or a quota,
tariffs offer at least two advantages to the country that imposes them: Some of the gains
go to the government rather than to foreign producers, and they provide greater incentive
for efficient production.
ON TEACHING THE CHAPTER
Chapter 22 deals with the microeconomics of the international economy. This chapter is very
important. There is an unfortunate tradition in American economics education of neglecting the
international sector. Instructors who are pressed for time sometimes never get to it. But the
international economy is becoming increasingly central to American well-being, both because
the ratio of trade to GDP has increased, and also because the position of dominance in the
international economy that the United States had after World War II has disappeared, with the
consequence that the country is much more vulnerable to foreign economic events than it once
was.
Students are likely to arrive in the course with some strong opinions about international
economics. They may feel that foreigners are being unfair to Americans, or that Americans are
losing their competitive edge, or that multinational corporations are exploitative, or that
Chapter 22/International Trade and Comparative Advantage
PROBLEMS
1. Only two goods are produced in the world’s two countries, Japan and Taiwan. In Japan,
one worker can produce 50 pairs of shoes or 50 electronic calculators. In Taiwan, one
worker can produce 40 pairs of shoes or 20 calculators.
a) In the absence of trade, what is the opportunity cost (i) of Japanese shoes, (ii) of
Taiwanese shoes, (iii) of Japanese calculators, and (iv) of Taiwanese calculators?
b) Assuming each country has the same number of workers, draw the production
possibility curves for each country, on separate diagrams.
c) Which country has the absolute advantage in the production of each good? The
comparative advantage?
d) Suppose trade is opened up between the two countries. What is a likely price ratio of
shoes and calculators in the single international market?
e) On the Japanese diagram, after trade has been opened, show consumption,
production, imports, and exports of both goods.
f) How would the comparative advantage change if a Japanese worker could produce (i)
75 pairs of shoes, (ii) 125 pairs of shoes, while the other production possibilities
remained constant?
Solution:
a) (i) one calculator, (ii) 0.5 calculators, (iii) one pair of shoes, (iv) two pairs of shoes
Chapter 22/International Trade and Comparative Advantage
e)
2. A car can be produced by 20 workers in the United States, and by 10 workers in
Germany. A 1,000 chickens can be produced by 25 workers in the United States, and by
20 workers in Germany.
a) Which country has the absolute and comparative advantages in the production of each
good?
b) In the absence of trade, what are the price ratios between the two goods in each
country?
c) Show how a shift of workers toward one of the two industries in the United States,
coupled with a shift of workers toward the other in Germany, could result in increased
total production of both goods in the two countries.
d) Suppose that when trade opens, the international price ratio settles at the former
German price ratio. Using diagrams, show what happens to production, consumption,
exports, and imports (i) in the United States and (ii) in Germany.
Solution:
a) Germany has absolute advantage in the production of both goods. The United States
DISCUSSION QUESTIONS
1. Argue for or against these propositions:
a) The United States should impose a 20 percent tariff for five years against the import
of any manufactured good that is currently available only from imports and which a
U.S. company is prepared to manufacture. This five-year period of protection will
allow the domestic producer to achieve competitive international costs.
b) The United States should impose tariffs to protect the heart of its manufacturing
sector, which has recently been losing ground internationally—in such products as
Chapter 22/International Trade and Comparative Advantage
steel, autos, chemicals, and machine tools. No country can be strong that is not
self-sufficient in these critical products.
c) One of the problems with the doctrine of free trade is that as comparative advantage
shifts, and some domestic industries are no longer competitive internationally, plants
close, jobs are lost, and whole communities and regions suffer. There is a tremendous
human cost involved. We should erect tariff barriers to prevent plant closings and the
human suffering that is attendant upon them.
d) Free trade is fine in theory, but only if all countries abide by the rules. Today, the
United States is encountering many countries that give their export industries unfair
subsidies and that find ways to exclude American exports from their markets. To
protect American incomes, we should impose retaliatory tariffs and quotas.
e) Of course, American textile companies cannot compete against imports from Asia and
Latin America. They pay their workers starvation wages over there. It is unfair
competition, and we should protect ourselves by imposing tariffs on foreign textiles.
f) For several decades after World War II, the United States was the principal proponent
of free trade in the world. Other countries followed the American lead, and the
industrialized world prospered as a result. Today, Americans are turning their backs
on free trade. They mistakenly think that tariffs and quotas can solve their
international problems, which in fact are caused by declining rates of productivity
growth and low domestic savings rates. For the welfare and prosperity of our country,
it is critical to reject protectionism.
g) The North American Free Trade Agreement will enhance the prosperity of most
Americans.
Suggested Answer: Student should come up with various arguments supporting or
2. Some people argue that poverty in the Third World is beneficial to the United States: Low
wages in the countries of Asia, Africa, and Latin America lead to low prices of the raw
materials that they export, and consequently to low costs of production and prosperity in
the United States. Others argue that a prosperous Third World would benefit the United
States, because people with rising incomes would buy more American exports, and this
would support American employment and GDP. Furthermore, high wages in the Third
World would prevent the people of those countries from competing unfairly with
Americans on the basis of their cheap labor. Which view do you think is most nearly
correct?
Suggested Answer: Answers will vary according to perceptions. Each view has its own
3. As the comparative advantage of the United States has changed over the last 20 years,
who in the country has benefited, and who has been hurt?
Suggested Answer: To discuss this question, students should read different studies on the
4. The United States has decided to support its domestic sugar producers by limiting the
imports of foreign sugar. Assume for the moment that this is a sound policy decision. Will
the country be better off by imposing a quota on sugar imports or a tariff? (Assume that
the two would have equal effects on the quantity of imports.)
Chapter 22/International Trade and Comparative Advantage
Suggested Answer: Although both tariffs and quotas reduce international trade and
increase the prices of domestically produced goods, there are some important differences