CHAPTER 55
Debate on Free Trade
LEARNING OBJECTIVES
Compare and contrast the arguments for and against free trade between countries.
Explain the comparative advantage model of trade (including the assumptions for the
OUTLINE OF CHAPTER
I. The Debate on the Eve of the Civil War
II. Comparative Advantage
III. Absolute and Comparative Advantage
KEY TERMS
absolute advantage
producing goods and services with the fewest inputs or at the lowest cost
comparative advantage
produc
ing a good or service at the lowest opportunity cost
free trade
without any barriers
started industrial development
quota
a quantity restriction on imported goods
subsidy
grants of money from the government
tariff
a tax on imported goods
ANSWERS TO END OF CHAPTER REVIEW QUESTIONS
Compare and contrast the arguments for and against free trade between countries.
a. What is the difference between a tariff and a quota? Why would advocates of free trade
see these policy tools as reducing consumer welfare?
2. What would be arguments used to justify barriers to free trade, such as tariffs and –
quotas?
Barriers to free trade are justified by arguments that domestic industries should be
Explain the comparative advantage model of trade (including the assumptions for the
model) and how it is used to argue for free trade.
3. Explain how comparative advantage differs from absolute advantage.
Comparative advantage argues that a country should produce the good with the lowest
4. What are the assumptions behind the simple static theory of comparative advantage?
1) Nations are operating on their production possibility curves, and there is no
unemployment of resources.
5. Following are the production possibilities curves for the fictional nations of Bergsakeria
and Solbergia showing their respective capacities for producing gizmos (G) and widgets
(W). Use this information to answer the questions that follow.
G
W
G
W
50
0
40
0
45
1
30
1
40
2
20
2
35
3
10
3
30
4
0
4
25
5
20
6
15
7
10
8
5
9
0
10
a. Which nation has an absolute advantage in producing gizmos (and widgets for that
matter)? Explain.
b. Which nation has a comparative advantage in producing gizmos? How do you know?
The cost of producing one additional G in Bergsakeria is 1/5 W.
c. Which nation has a comparative advantage in producing widgets? Explain.
The cost of producing one additional W in Bergsakeria is 5 G.
Cite historical and current examples of protectionism and the free trade debate.
6. Why do Europe and the U.S. both want to maintain agricultural subsidies? Why do –
developing countries argue the U.S. and Europe should drop the subsidies?
Developed countries want to maintain agricultural subsidies in order to protect domestic
7. What is the WTO? Is it effective in enforcing trade policies? Why or why not?
World Trade Organization. The WTO has been at the center of violent disagreement
APPENDIX 55.1
Conservative Defense of Comparative Advantage
LEARNING OBJECTIVES FOR APPENDIX 55.1
Use the comparative advantage model to explain the terms of trade
Explain the predicted and actual outcomes of free trade based on the comparative
advantage model.
OUTLINE OF APPENDIX
I. The Conservative Side of the Debate
KEY TERMS
autarky
ANSWERS TO APPENDIX 55.1 REVIEW QUESTIONS
Use the comparative advantage model to explain the terms of trade
1. Demonstrate using a PPF graph why both countries can be made better off by
specialization and trade.
2. Describe how two countries might arrive at mutually agreeable terms of trade.
Explain the predicted and actual outcomes of free trade based on the comparative
advantage model.
3. Explain why would both countries be better off specializing and trading even if one
country produces more of all goods.
Even if one country has an absolute advantage in both goods, there will be more overall
4. In the real world, what might interfere with the results predicted by the model?
The results predicted by the model are based on fairly restrictive assumptions labor is
APPENDIX 55.2
Criticisms of Comparative Advantage
LEARNING OBJECTIVES FOR APPENDIX 55.2
Compare and contrast alternative models of trade.
Discuss how alternative models seek to address weaknesses in the comparative advantage
model.
OUTLINE OF APPENDIX
I. Distributional Problems within a Nation
II. Heckscher-Ohlin Model and Capital Intensity
KEY TERMS
Heckscher-Ohlin model
a mathematical comparative advantage model that assumes similar technology across countries
ANSWERS TO APPENDIX 55.2 REVIEW QUESTIONS
Compare and contrast alternative models of trade.
1. How does the Heckscher-Ohlin model challenge the traditional model of comparative
advantage? What are problems with both models?
The Heckscher-Ohlin model incorporates the usual assumptions of perfect competition,
2. How does the Prebisch-Singer hypothesis challenge the comparative advantage model of
trade?
The Prebisch-Singer hypothesis challenges the assumption that the potential gains from
Discuss how alternative models seek to address weaknesses in the comparative advantage
model.
3. Explain the need to go beyond the analysis of static comparative advantage according to
modifications of the assumptions, paying particular attention to
a. Transportation costs
b. Factor proportions
Factor proportions are excluded from the traditional model. They are incorporated in
c. Human capital and knowledge
The most significant challenge to comparative advantage is the idea that production
d. Distribution of benefits and costs of trade
The gains from trade involve gains to some industries and losses to others. The export
e. Economies of scale and monopolistic competition
Economies of scale and monopolistic competition are characterized by conditions that
f. The product cycle and industrial metamorphoses
Comparative advantage fails to take into account the evolutionary process by which
g. Anomalous terms of trade between primary and manufactured goods
The Prebisch-Singer hypothesis argues that countries exporting agricultural products are
4. Explain the possible policy implications for the need to develop along the lines of South
Korea rather than Chile. Pay particular attention to (a) free trade versus protection, (b)
industry, and (c) education and infrastructure spending.
South Korea adopted a policy of active promotion of certain key export industries in
5. Counter to the predictions of static comparative advantage, explain why advanced
nations trade mostly among themselves (along with the select new area that become part
of their strategic alliances and partnerships).
A great deal of international trade is intra-industry trade and intra-firm. For example, a
6. Why might the product cycle provide an explanation for export success and then failure,
while static comparative advantage fails to comprehend the evolutionary aspects of
trade?
The product cycle suggests initial development of a product is followed by production for
7. Why may developing nations find it advantageous to protect their new technology
industries and provide infrastructure such as roads, education, and health services to
stimulate human capital when they currently do not have a static comparative advantage
in new technology products.
The case of South Korea versus Chile discussed in the book demonstrates that a free
8. Why have South Korea, Taiwan, and Singapore been so successful at technologically
advanced processes and products when static comparative advantage indicated that they
should have concentrated on low-value-added goods forty years ago? Why, on the other
hand, have such apparently promising nations such as Chile and Brazil not advanced that
much in development compared with these previously low-development East Asian
nations?