Chapter 37

International
Trade

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Objectives
• Comparative advantage and the
gains from trade
• Exports and imports
• Economic effects of tariffs and
quotas
• Arguments for protectionism

37-2
 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
 World Exports
Percentage Share of World Exports,
Selected Nations, 2007

0 2 4 6 8 10 12

Germany 9.20
United States 8.59
China 8.02
Japan 5.38
France 4.06
Netherlands 3.83
United Kingdom 3.71
Italy 3.40

Source: World Trade Organization

37-4
 Economic Basis for Trade

• Nations have different resource

endowments
• Labor-intensive goods
• Land-intensive goods
• Capital-intensive goods

37-5
 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
 Comparative Advantage
45 45

40 (a) United States 40 (b) Brazil

35 35

30 30

Coffee (Tons)
Coffee (Tons)

25 25

20 20

15 15
12
10 A 10

5 5
4
B
0 0
5 10 15 18 20 25 30 5 8 10 15 20
37-7
Wheat (Tons) Wheat (Tons)
 Comparative Advantage
• 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

37-8
 Comparative Advantage
• 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 37-9
 Comparative Advantage
• Gains from trade
–Trade possibilities line
–Slope equals terms of trade
–Improved options
• Complete specialization
• More of both goods
• More efficient resource allocation
37-10
 Economic Basis for Trade
45 45
C’
(a) United States (b) Brazil
40 40

35 35
Trading
C Possibilities Line
30 30

Trading

Coffee (Tons)
Coffee (Tons)

25 25
Possibilities Line
20 20
c

A’
15 15
12
10 A 10

B’
5 5
4
B
0
W
0 w w’
5 10 15 18 20 25 30 5 8 10 15 20
Wheat (Tons) Wheat (Tons)
37-11
 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
 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
Supply and Demand Analysis
(a) U.S. Domestic (b) U.S. Export Supply
Aluminum Market and Import Demand

Surplus = 100
Sd
Price (Per Pound; U.S. Dollars

Price (Per Pound; U.S. Dollars

1.50 1.50
c
Surplus = 50
U.S.
1.25 1.25 Export
b
Supply
1.00 1.00 a
U.S.
Import
.75 .75 Demand
Shortage = 50 x
.50 .50
Dd y
Shortage = 100
0 0
50 75 100 125 150 50 100
Quantity of Aluminum Quantity of Aluminum
(Millions of Pounds) (Millions of Pounds)
37-14
Supply and Demand Analysis
(a) Canada’s Domestic (b) Canada’s Export Supply
Aluminum Market and Import Demand
Price (Per Pound; U.S. Dollars

Price (Per Pound; U.S. Dollars

1.50 1.50
Surplus = 100
Sd
1.25 1.25
s
Surplus = 50
1.00 1.00 Canadian
r Export
Supply
.75 .75 q
Canadian
Import
.50 .50
Demand
Shortage = 50 t
Dd
0 0
50 75 100 125 150 50 100
Quantity of Aluminum Quantity of Aluminum
(Millions of Pounds) (Millions of Pounds)
37-15
 International Equilibrium
Import demand = Export supply

U.S.

Price (Per Pound; U.S. Dollars

Export
Supply

Canadian
1.00
Export
e Supply
.88 Equilibrium
.75 U.S.
Import
Demand

Canadian
Import Demand
0
50 100
Quantity of Aluminum
(Millions of Pounds)
37-16
 Trade Barriers

• Tariffs
–Revenue tariff
–Protective tariff
• Import quota
• Nontariff barrier (NTB)
• Voluntary export restriction
(VER)

37-17
 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
 Trade Barriers
Economic Effects of a Tariff or Quota
Sd

Sd + Q
Price

Pd

Pt
Pw

Dd

0 a b q c d
Quantity
37-19
 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
 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
 Key Terms
• labor-intensive goods
• land-intensive goods
• capital-intensive goods
• opportunity-cost ratio
• principle of comparative
advantage
• terms of trade
• trading possibilities line
• gains from trade
• world price
• domestic price
• export supply curve
• import demand curve
• equilibrium world price
• tariffs
• revenue tariff
• protective tariff
• import quota
• nontariff barrier (NTB)
• voluntary export restriction
(VER)
• strategic trade policy
• dumping
• Smoot-Hawley Tariff Act
• World Trade Organization
(WTO)
• Doha Round
37-22
Next Chapter Preview…

Exchange Rates, the

Balance of Payments,
and Trade Deficits

37-23