Case & Fair (Ch.

33)

TOPIC 9:
INTERNATIONAL
TRADE
CHAPTER OUTLINE

Trade Surplus and Trade Deficit

The Basic of Trade
Absolute advantage vs Comparative advantage
Terms of trade
Trade Barriers
Tariffs
Exports subsidies
Quotas
The Case of Protection
TRADE SURPLUSES & DEFICITS
 All economies, regardless of their size, depend
to some extent on other economies & are
affected by events outside their borders.

 Trade surplus – the situation when a country

exports > imports.

 Trade deficit – the situation when a country

imports > exports.

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ABSOLUTE VS. COMPARATIVE
ADVANTAGE
 Absolute advantage – the advantage in the
production of a product enjoyed by 1 country
over another when it uses fewer resources to
produce that product than the other country.

 Comparative advantage – the advantage in

the production of a product enjoyed by one
country over another when that product can be
produced at lower cost in terms of other goods
(a.k.a. opportunity cost) than it could be in the
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other country.
Absolute vs. Comparative Advantage
(cont.)
 Assume that only 2 countries in the world,
New Zealand & Australia.
 Each country produce wheat & cotton.

Yield per Acre of Wheat and Cotton

Wheat Cotton
New Zealand 6 bushels 3 bales
Australia 3 bushels 6 bales

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Absolute vs. Comparative Advantage
(cont.)
Yield Per Acre of Wheat & Cotton
Country Wheat Cotton
New Zealand 6 3
Australia 3 6

 New Zealand enjoys absolute advantage

in the production of ______.
 Australia enjoys absolute advantage in
the production of _______. 6
Absolute vs. Comparative Advantage
(cont.)
Yield Per Acre of Wheat & Opportunity
Cotton cost
Country Wheat Cotton Wheat Cotton
New Zealand 6 3 0.5C 2W
Australia 3 6 2C 0.5W

 New Zealand enjoys comparative advantage

in the production of _______. (lower opp.
cost)
 Australia enjoys comparative advantage in
the production of ______. (lower opp. cost) 7
 Assume: constant opp. cost
Absolute vs. Comparative Advantage
(cont.)
• Given each country has 100 acres of land, used
to produced wheat & cotton in both countries.
• Assume that both countries divide land evenly
in the production of wheat & cotton.

Land used in the Production of Wheat and

Cotton
Wheat Cotton
New Zealand 50 50
Australia 50 50
Absolute vs. Comparative Advantage
(cont.)
Land used in Yield per Acre Total output before
the Production specialization

Country Wheat Cotton Wheat Cotton Wheat Cotton

New 50 50 6 3 ?? ??
Zealand acres acres bushels bales

Australia 50 50 3 6 ?? ??
acres acres bushels bales

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Absolute vs. Comparative Advantage
(cont.)
Production Possibilities
Frontier (PPF) for NZ:
wheat
Production Possibilities
Frontier for Australia:
wheat

cotton cotton
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Absolute vs. Comparative
Advantage (cont.)
 When countries specialized in producing goods in
which they have a comparative advantage, they
maximize their combined output and allocate their
resources more efficiently.

 Trade enables both countries to move beyond their

previous resource and productivity constraints.

 Terms of trade (TOT) – the ratio at which a country

can trade domestic products for imported products.
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Absolute vs. Comparative
Advantage (cont.)
 Both parties must have something to gain
for trade to take place.
 When setting the TOT, we have to consider
the opportunity costs for both countries in
both production.
Opp. Cost for Opp. Cost for
NZ: Australia: Range of TOT:

1W = 0.5C 1W = 2C 0.5C < 1W < 2C

1C = 2W 1C = 0.5W 0.5W < 1C < 2W
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Absolute vs. Comparative Advantage
(cont.)
• NZ specialized in the production of wheat due to
lower opp. cost.
• Australia specialized in the production of cotton.
Total output before Total output after
specialization specialization

Country Wheat Cotton Wheat Cotton

New Zealand 300 150 ?? ??

bushels bales

Australia 150 300 ?? ??

bushels bales
 Absolute vs. Comparative Advantage
(cont.)
 Assume that TOT: 1W = 1C
 NZ imports 200 cottons from Australia.

 In exchange, NZ exports 200 wheat to Australia.

Total output Total output after Output after Trade
before specialization (TOT: 1W=1C)
specialization

Country Wheat Cotton Wheat Cotton Wheat Cotton

New 300 150 600 0 ?? ??

Zealand bushels bales bushels

Australia 150 300 0 600 ?? ??

bushels bales bales
 Absolute vs. Comparative Advantage
(cont.)
 Both countries gain from the trade as the output
after trade more than before specialization.

Total output Output after Gain from Trade

before Trade
specialization (TOT: 1W=1C)

Country Wheat Cotton Wheat Cotton Wheat Cotton

New 300 150 400 200

Zealand bushels bales bushels bales

Australia 150 300 200 400

bushels bales bushels bales
Absolute vs. Comparative Advantage
(cont.)
Production Possibilities Frontier (PPF) Production Possibilities Frontier
& Trading Possibilities Frontier (TPF) (PPF) & Trading Possibilities
for NZ: Frontier (TPF) for Australia:
wheat wheat

cotton cotton

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TRADE BARRIERS
 Trade barriers (a. k. a obstacles to trade) aims to
protect some sector of the economy from foreign
competition.

 3 most common forms:

1. Tariff – a tax on imports

2. Export subsidies – govt. payments made to

domestic firms to encourage exports.

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3. Quota – a limit on the quantity of imports.
THE CASE FOR PROTECTION
1. Protection save jobs

2. Some countries engage in unfair trade practices

3. Cheap foreign labor makes competition unfair

4. Protection safeguard national security

5. Protection discourages dependency

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6. Protection safeguards infant industries