Chapter 9

International
Trade

1
International Trade
• All economies, regardless of their
size, depend to some extent on other
economies and are affected by
events outside their borders.
• The “internationalization” or
“globalization” of the U.S. economy
has occurred in the private and public
sectors, in input and output markets,
and in business firms and
households.
The Economic Basis for Trade:
Comparative Advantage
• Corn Laws were the tariffs, subsidies, and
restrictions enacted by the British Parliament
in the early nineteenth century to discourage
imports and encourage exports of grain.

• David Ricardo’s theory of comparative

advantage , which he used to argue against
the corn laws, states that specialization and
free trade will benefit all trading partners
(real wages will rise), even those that may
be absolutely less efficient producers.
 Absolute Advantage Versus
Comparative Advantage
• A country enjoys an absolute advantage
over another country in the production of a
product if it uses fewer resources to produce
that product than the other country does.

• A country enjoys a comparative

advantage in the production of a good if
that good can be produced at a lower cost in
terms of other goods.
Mutual Absolute Advantage
YIELD PER ACRE OF WHEAT AND COTTON
NEW ZEALAND AUSTRALIA
Wheat 6 bushels 2 bushels
Cotton 2 bales 6 bales

• In this example, New Zealand can produce three

times the wheat that Australia can on one acre of
land, and Australia can produce three times the
cotton. We say that the two countries have mutual
absolute advantage.
Mutual Absolute Advantage
• Suppose that each country divides its land to obtain
equal units of cotton and wheat production.
TOTAL PRODUCTION OF WHEAT AND COTTON
ASSUMING NO TRADE, MUTUAL ABSOLUTE
ADVANTAGE, AND 100 AVAILABLE ACRES
NEW ZEALAND AUSTRALIA
Wheat 25 acres x 6 bushels/acre 75 acres x 2 bushels/acre
150 bushels 150 bushels

Cotton 75 acres x 2 bales/acre 25 acres x 6 bales/acre

150 bales 150 bales
Production Possibility Frontiers for
Australia and New Zealand Before
Trade

• Because both countries have an absolute advantage

in the production of one product, specialization and
trade will benefit both.
 Gains from Specialization
• An agreement to trade 300 bushels of wheat for
300 bales of cotton would double both wheat and
cotton consumption in both countries.
PRODUCTION AND CONSUMPTION OF WHEAT
AFTER SPECIALIZATION
PRODUCTION CONSUMPTION
NEW NEW
AUSTRALIA AUSTRALIA
ZEALAND ZEALAND

Wheat 100 acres x 6 bu/acre 75 acres x 2 bu/acre 300 bushels 300 bushels
600 bushels 150 bushels

Cotton 0 acres 100 acres x 6 bales/acre 300 bales 300 bales

0 600 bales
Gains from Specialization
 Gains from Comparative
Advantage
• Even if a country had a considerable absolute
advantage in the production of both goods,
Ricardo would argue that specialization and
trade are still mutually beneficial.
• When countries specialize in producing the
goods in which they have a comparative
advantage, they maximize their combined
output and allocate their resources more
efficiently.
Gains from Comparative
Advantage
• The real cost of producing
cotton is the wheat that
must be sacrificed to
produce it.
• A country has a
comparative advantage in
cotton production if its
opportunity cost, in terms
of wheat, is lower than the
other country.
Gains from Comparative
Advantage
Gains from Comparative
Advantage
• To illustrate the gains from comparative
advantage, assume (again) that in each country
people want to consume equal amounts of cotton
and wheat. Now, each country is constrained by
its domestic production possibilities curve, as
follows:
YIELD PER ACRE OF WHEAT AND COTTON
NEW ZEALAND AUSTRALIA
Wheat 6 bushels 1 bushel
Cotton 6 bales 3 bales
Gains from Comparative
Advantage
TOTAL PRODUCTION OF WHEAT AND COTTON
ASSUMING NO TRADE AND 100 AVAILABLE ACRES
NEW ZEALAND AUSTRALIA
Wheat 50 acres x 6 bushels/acre 75 acres x 1 bushels/acre
300 bushels 75 bushels

Cotton 50 acres x 6 bales/acre 25 acres x 3 bales/acre

300 bales 75 bales

• The gains from trade in this example can be

demonstrated in three stages.
Gains from Comparative
Advantage
• Stage 1: Australia transfers all its land into cotton
production. New Zealand cannot completely
specialize in wheat because it needs 300 bales of
cotton and will not be able to get enough cotton
from Australia (if countries are to consume equal
amounts of cotton and wheat).
REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY
HAS A DOUBLE ABSOLUTE ADVANTAGE
STAGE 1
NEW ZEALAND AUSTRALIA
Wheat 50 acres x 6 bushels/acre 0 acres
300 bushels 0

Cotton 50 acres x 6 bales/acre 100 acres x 3 bales/acre

300 bales 300 bales
Gains from Comparative
Advantage
• Stage 2: New Zealand transfers 25 acres out of
cotton and into wheat.

REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY

HAS A DOUBLE ABSOLUTE ADVANTAGE
STAGE 2
NEW ZEALAND AUSTRALIA
Wheat 75 acres x 6 bushels/acre 0 acres
450 bushels 0

Cotton 25 acres x 6 bales/acre 100 acres x 3 bales/acre

150 bales 300 bales
Gains from Comparative
Advantage
• Stage 3: Countries trade
REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY
HAS A DOUBLE ABSOLUTE ADVANTAGE
STAGE 3
NEW ZEALAND AUSTRALIA
100 bushels (trade)

Wheat 350 bushels 100 bushels

(after trade)
200 bushels (trade)

Cotton 350 bales 100 bales

(after trade)
Gains from Comparative
Advantage

• Both countries are better off than they were

before trade. Both have moved beyond their own
production possibility frontiers.
 International Trade
• Exports—goods and services produced in
one country and sold to other countries.
• Imports—goods and services consumed
in a country but which have been
purchased from other countries.
• Trade Deficit (Surplus)—a country has
a trade deficit (surplus) if its imports
(exports) exceeds its exports (imports).
 Index of Openness
• Index of Openness—a measure of how
much a country participates in
international trade; defined as the ratio of
a country’s exports to its GDP (or GNP).
• Open Economy—a country with a high
value of the index of openness.
• Closed Economy—a country with a
relatively low index of openness.
 Causes of Differences in Economic
Growth of Countries

• Quantity and quality of resource

endowments, particularly human capital
• Investment in plant and equipment
(capital)
• Political and socioeconomic environment
that is stable and conducive to
competition
Growth of World Exports

• What has caused the explosion of world

trade?
– Reduction in trade barriers
– Advances in transportation, communication
and technology
– Proliferation of trade agreements
Geographic Trade Patterns

• Developed countries account for the bulk

of world trade (largest exporters and
importers).
• Developed countries trade primarily with
each other.
• Developing countries rely on developed
countries for their export markets.
• Countries trade mainly with neighbors.
Commodity Composition

• Top three most traded products

– Petroleum
– Office machines, computers, and parts
– Automobiles
• Increased role of global production (or
outsourcing)