Microeconomics Canadian 2nd Edition

Hubbard Solutions Manual

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CHAPTER 7 | Comparative Advantage
and the Gains from
International Trade
SOLUTIONS TO END-OF-CHAPTER EXERCISES
Review Questions
Canada and the International Economy (pages 168–169)
7.1 Learning Objective: Discuss the role of international trade in the Canadian economy.
1.1 Since the early 1960s Canada’s exports have generally been larger than imports. The current
situation has Canadians importing more than they export.
1.2 Although Canada is a major exporter, Figure 7.2 shows that many other countries export a
lot more than Canada. Figure 7.3 shows that countries like Germany, the U.K., and the
Netherlands export and import much higher proportions of their GDP than Canada.
Comparative Advantage in International Trade (pages 169–171)
7.2 Learning Objective: Understand the difference between absolute and comparative
advantage in international trade.
2.1 Absolute advantage is the ability to produce more of a good or service than competitors using
the same amount of resources. Comparative advantage is the ability to produce a good or
service at a lower opportunity cost than other producers. A country will often import goods in
which it has an absolute advantage. For example, Canada could produce textiles—such as
sheets and towels—with fewer resources than China can, but China can produce these goods
at a lower opportunity cost than Canada. Importing textile products from China frees up
resources Canada can use to produce other goods in which it has a comparative advantage.
2.2 Comparative advantage is the ability of an individual, a firm, or a country to produce a good
or service at the lowest opportunity cost. This insight is powerful because it runs counter to
most people’s intuition that trade is based on absolute advantage. Applying the economic
concept of comparative advantage allows us to analyze which products countries tend to
export and which they tend to import. The concept also allows us to see the immense
gains—to rich and poor alike—that trading can generate.
How Countries Gain from International Trade (pages 171–175)
7.3 Learning Objective: Explain how countries gain from international trade.
3.1 Complete specialization would mean producing only one good. It is not typical for a
country to completely specialize because not all goods and services are traded
internationally. In addition, the production of most goods involves increasing opportunity
costs, which means that before complete specialization is reached, a country may have lost
its comparative advantage in producing a good. Finally, tastes for products differ across
countries, so different countries may have comparative advantages in different varieties of
the same good which leads to intra-industry trade.

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 CHAPTER 7 | Comparative Advantage and the Gains from International Trade 51

3.2 Not everyone gains from international trade. Suppose, based on comparative advantage, it is
determined that Japan should only produce cell phones and Canada should produce only
tablet computers. The owners of Japanese table computer companies, the owners of
Canadian cell phone firms, and the people who work for them may be worse off as a result
of trade.

Government Policies that Restrict International Trade (pages 175–183)

7.4 Learning Objective: Analyze the economic effects of government policies that restrict
international trade.

4.1 A tariff is a tax governments impose on imports. A quota is a numerical limit a government
imposes on the quantity of a good that can be imported into the country. Non-tariff barriers
include governmental rules—for example, health or safety regulations—that favour
domestic firms over foreign firms.

4.2 The winners from tariffs are domestic producers and the government. The losers are
domestic consumers and domestic firms that use as an input the product that is protected by
the tariff or quota—as, for example, the Canadian pizza industry loses as a result of the
Canadian cheese quota. The winners from quotas are domestic producers and whoever
holds the import license. The losers, again, are domestic consumers.

The Arguments over Trade Policies and Globalization (pages 183–188)

7.5 Learning Objective: Evaluate the arguments over trade policies and globalization.

5.1 Globalization is the process of countries becoming more open to foreign trade and
investment. Some people oppose globalization because they believe it will make them
worse off or will harm other people they care about—especially poor workers in developing
countries. Some opponents of globalization believe that it undermines the local cultures in
developing countries.

5.2 Protectionism is the use of trade barriers to shield domestic companies and their workers
from foreign competition. The beneficiaries are the protected domestic companies and their
workers. The losers are domestic consumers and other domestic producers who cannot buy
their inputs as cheaply. The main arguments for protectionism are that it saves jobs and
protects high wages; allows “infant industries” a chance to get started and grow; and
protects national security. It is important to weigh the benefits of each of these arguments
against the costs.

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52 CHAPTER 7 | Comparative Advantage and the Gains from International Trade

Problems and Applications

Canada and the International Economy (pages 168–169)

7.1 Learning Objective: Discuss the role of international trade in the Canadian economy.

1.1 Agriculture would see a large decline, as would certain manufacturing industries, such as
cars. Many service industries, such as haircutting and medical services, would not be
affected much because Canada does not export services of these types.

1.2 Smaller countries generally do not produce as large and as diverse a group of goods and
services as larger countries do. Smaller countries are therefore more likely than larger
countries to export and import larger fractions of their GDP.

Comparative Advantage in International Trade (pages 169–171)

7.2 Learning Objective: Understand the difference between absolute and comparative
advantage in international trade.

2.1 The goods that countries import and export change over time because the goods in which
they have a comparative advantage change over time. These changes can be caused by
technological change as well as changes in the relative abundance of resources.

2.2 The argument does not make sense because Bolivia must have a comparative advantage in
producing at least one good. Remember that comparative advantage compares opportunity
costs of producing goods between two countries. If Canada has a lower opportunity cost in
one good, then it must have a higher opportunity cost in some other good, which would give
Bolivia the comparative advantage in producing the other good.

2.3
Opportunity Costs
Olive Oil Pasta
Greece 0.5 pasta 2 olive oil
Italy 2 pasta 0.5 olive oil

2.4 Based on comparative advantage, some jobs in Canada will be lost to countries that have
lower opportunity costs in producing certain goods and services. If T-shirts can be produced
at a lower opportunity cost in another country, then it makes economic sense for T-shirts to
be produced in that country. Although an individual who loses his job as a result of imports
from another country may be justifiably upset and prefer to pay a higher price for a product
to keep production at home, consumers in general are better off by purchasing goods from
countries that have a comparative advantage, as this will allow resources in Canada to be
more efficiently allocated to goods and services in which Canada has a comparative
advantage.

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 CHAPTER 7 | Comparative Advantage and the Gains from International Trade 53

How Countries Gain from International Trade (pages 171–175)

7.3 Learning Objective: Explain how countries gain from international trade.

3.1 Firms like Bombardier and Magna oppose tariffs and other policies to protect Canadian
firms from foreign competition because they sell most of their products in other countries. If
Canada imposes tariffs on imports from other countries, those countries are likely to impose
tariffs on Canadian made goods. For example, say Canada decided to impose a tariff on US
and European products. The US and Europe would likely retaliate by putting tariffs on
Canadian made car parts, aircraft, and train cars. These foreign tariffs would do a lot of
harm to Magna and Bombardier.

3.2 a. A country has an absolute advantage over another country when it can produce more of
a good using the same resources. Chile has an absolute advantage in the production of
both hats and beer because it can produce more of both goods (8 hats; 6 barrels of beer)
than can Argentina (1 hat; 2 barrels of beer) with the same amount of labour input.
b. A country has a comparative advantage when it can produce a good at a lower
opportunity cost. To produce 8 hats, Chile must give up 6 barrels of beer. Therefore, the
opportunity cost to Chile of producing 1 hat is 6/8, or 0.75 barrels of beer. Argentina
must give up 2 barrels of beer to produce 1 hat, so its opportunity cost of producing
1 hat is 2 barrels of beer. Chile has a comparative advantage in the production of hats
because its opportunity cost is lower. To produce 6 barrels of beer, Chile must give up
8 hats, so its opportunity cost of producing 1 barrel of beer is 8/6, or 1.33 hats.
Argentina must give up 1 hat to produce 2 barrels of beer, so its opportunity cost of
producing 1 barrel of beer is 0.5 hats. Argentina has a comparative advantage in the
production of beer because its opportunity cost is lower.
c. As part (b) shows, Chile should specialize in producing hats, and Argentina should
specialize in producing beer. By specializing, Chile can produce 8,000 hats
(1,000 labour-hours × 8 hats), and Argentina can produce 2,000 barrels of beer
(1,000 labour hours × 2 barrels of beer). If Chile trades 700 hats to Argentina for
700 barrels of beer, the countries will end up with:
Hats Beer
Chile 7,300 700
Argentina 700 1,300

Both countries are better off than they were before specializing and engaging in trade.

3.3 The commentator is confusing absolute advantage and comparative advantage. Absolute
advantage is the ability to produce more of a good or service than competitors when using
the same amount of resources. Comparative advantage is the ability of an individual, a firm,
or a country to produce a good or service at a lower opportunity cost than competitors.
Every country, no matter how poor, will have a comparative advantage in producing some
good. (Often countries are poor because they cannot or will not trade with others.)

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54 CHAPTER 7 | Comparative Advantage and the Gains from International Trade

3.4 As explained in the text, this statement is correct. Production of most goods and services
involves increasing opportunity costs.
3.5 Free trade probably benefits smaller countries more because without trade it would be
difficult for producers in these countries to benefit from external economies and economies
of scale. Also, larger, more populous countries are likely to have a wider range of both
natural resources and people with particular skills, so these countries can gain significantly
from internal trade, but this is less likely in smaller countries.
3.6 Trade allows a country to specialize in producing the goods in which it has a comparative
advantage. After trading, the country can consume more. In this sense, a country can
“produce more with less” and consumers win. Thus making both statements correct.
3.7 Every trade involves costs to someone. Those firms and workers in industries that were
previously protected from international competition will likely lose out from a new trade
deal. When Canadians begin to buy imports they reduce their consumption of Canadian
made products. For example, if the TPP reduces protections for Canadian dairy producers,
many dairy farms and farm workers will find their businesses and jobs at risk as they will
begin to face more competition from lower cost foreign producers. They may have to find
employment in another industry in which Canada is better able to compete internationally.

Government Policies that Restrict International Trade (pages 175–183)

7.4 Learning Objective: Analyze the economic effects of government policies that restrict
international trade.

4.1 A trade deal with China would most likely benefit Canadians greatly. It would grant
Canadian consumers access to more products at lower prices than is currently the case. It
would also grant Canadian producers increased opportunities to sell their products in one of
the largest markets in the world – more than a billion new consumers to sell products to
would create a lot of opportunities to Canadian firms and their workers.
Canadian firms would also face additional competition from Chinese firms. It would be
very difficult for Canadian workers in some industries to match the low cost of production
China’s low wages and less rigorous labour standards allow.
Trade agreements typically receive more support from the public when they are between
countries with similar levels of development and labour standards. Japan, for example, has
wealthier consumers and workers paid in a manner similar to Canadian workers. The legal
system in Japan is closer to Canada’s than China’s is. People generally view this as meaning
they will be able to compete on a “level playing field” – firms in other countries won’t have
an unfair advantage over Canadian firms.
4.2 “Fighting protectionism” refers to governments resisting imposing tariffs, quotas, and non-
tariff barriers to protect domestic industries. “Populist policies” refers to policies supported
by the average person and designed to promote their rights and beliefs. Adopting populist
policies—in this case, the desire to enact protectionist policies to protect domestic
industries—is not consistent with the concept of comparative advantage and would result in
higher prices, lower consumption, and reduced efficiency, all of which would reduce
economic growth and therefore prolong the recession.

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 CHAPTER 7 | Comparative Advantage and the Gains from International Trade 55

4.3 a.

b.

Before the tariff, the quantity of beef sold by Canadian producers is Q1; after the tariff,
the quantity of beef sold by Canadian producers is Q3. Before the tariff, the quantity of
beef imported = Q2 – Q1; after the tariff, the quantity of beef imported = Q4 – Q3.
c. The winners from the tariff are domestic producers of beef and the government, which
collects the tariff revenue. The losers are domestic consumers of beef.

4.4 Firms producing goods in which Canada doesn’t have a comparative advantage will be the
most likely to be negatively affected by the Trans Pacific Partnership. Two industries that
have raised concerns about the deal and therefore indicate that they believe they will be
negatively affected are dairy producers and automotive industry. The TPP allows for
increased imports in both industries, so firms in these industries will face more competition.

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56 CHAPTER 7 | Comparative Advantage and the Gains from International Trade

4.5 The student’s reasoning is flawed. As we saw in the chapter, placing a tariff on imports of a
good will raise the price of the good. If foreign competition is entirely eliminated, the prices
charged by Canadian producers will rise as much as or more than they will if a tariff is
imposed, because eliminating imports will cause the supply curve for the protected good to
shift to the left. Also, if the imported goods are a different style or quality than the Canadian
goods, then Canadian consumers will have a reduced variety of goods from which to
choose.

4.6 Economists usually measure the standard of living by the goods and services that the typical
person in a country is able to purchase. In this case, the Chinese government will have
reduced the standard of living of its own people and raised the standard of living of people
in Canada. The standard of living in Canada is raised because Canadian consumers are able
to purchase Chinese goods at a price below their true cost of production. The standard of
living in China is reduced because the government has used some of the country’s resources
to cover the cost of goods that are sent to Canada. Subsidizing exports is essentially giving
money away to foreign consumers.

4.7 You can refer to Solved Problem 7.4 in the text for guidance in filling out the table.

Without Quota With Quota

World price of kumquats $0.75 $0.75
Canadian price of kumquats $0.75 $1.00
Quantity supplied by Canadian firms 4 million 6 million
Quantity demanded 13 million 12 million
Quantity imported 9 million 6 million
Area of consumer surplus A+B+C+D+E+F A+B
Area of domestic producer surplus G C+G
Area of deadweight loss None D+F

The Arguments over Trade Policies and Globalization (pages 183–188)

7.5 Learning Objective: Evaluate the arguments over trade policies and globalization.

5.1 Labour standards refer to the laws and practices governing working conditions and other
elements of employment. Labour standards cover everything from how long the working
day is, how many hours a week a person can work before they must be paid overtime, safety
precautions and other facets of work. Different countries will have different labour
standards based on the relative power of workers and local culture. Canadian laws generally
require firms to provide hard hats and other safety equipment. Laws in other countries,
particularly developing countries do not require the same safety equipment that Canadian
workers receive. Developing countries resist some labour standards like paid vacation time
or sick leave in part because these policies are expensive for employers – essentially these
policies mean hiring a worker costs more than it would otherwise.

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 CHAPTER 7 | Comparative Advantage and the Gains from International Trade 57

5.2 You should disagree with the statement because it doesn’t take into account the whole
process of international trade. Buying a less expensive good from Brazil leaves a consumer
with more money to spend on other domestic goods. In addition, buying a good from Brazil
provides Brazilians with the funds to buy goods from Canada. Importing goods does not
affect the total number of jobs in Canada. Buying only Canadian-produced products and
limiting imports results in higher prices of the Canadian-produced products. This in turn
makes these products more expensive for Canadians. When Canada imports products for
which it does not have a comparative advantage, it is able to purchase these imports more
cheaply, which in turn helps Canadian consumers and may help increase jobs. In the cell
phones and televisions example, the Canadian decision to export cell phones and import
televisions expanded world production and consumption of these two goods, and left
employment in Canada unchanged.

5.3 Trade agreements will harm some workers and help others. Not all workers will have the
same experience. Workers in industries facing increased competition from foreign firms
will likely be harmed. They may receive lower pay or even lose their jobs. Workers in firms
that are well suited to competition with foreign producers or producing in industries where
Canada has a comparative advantage are likely to be better off as a result of the trade deal.
All workers will receive access to a wider variety of lower priced products as a result of a
trade deal, however.

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