Chapter 3: International Trade

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Where We’ve Been; Where We’re Going

Following our introduction to globalization

Chapter 2 discussed the basic reason for
(Chapter 1), Chapter 3 examines the basic
the study of Economics: the need to make
economic principles that drive international
choices in a world of scarcity.
trade.
The Network of World Trade in Merchandise
Absolute Advantage
 A country has an absolute advantage in those products in
which it has a productivity edge over other countries.
 Two countries that each have an absolute advantage in different
products can gain from specializing (at least to some extent) in
the product where they have an absolute advantage and then
trading.

Giving up 1 Barrel of Oil gets Giving up 1 Barrel of Oil

you 1/6 Bushel of Corn gets you 4 Bushels of Corn

Giving up 1 Bushel of Corn Giving up 1 Bushel of Corn

gets you 6 Barrels of Oil gets you ¼ Barrel of Oil
Production Possibilities Frontiers and Absolute Advantage (1 of 3)
Production Possibilities Frontiers and Absolute Advantage (2 of 3)

Point A
Production Possibilities Frontiers and Absolute Advantage (3 of 3)

Saudi Arabia’s PPP

(from previous slide)
Point A
How Specialization by Absolute Advantage Expands Output

BEFORE Trade AFTER Trade

Trade and Opportunity Cost

4 1

1 6

Ratio of Exports to Ratio of Exports to

Imports must be: Imports must be:
LESS THAN 4-to-1 LESS THAN 6-to-1
Comparative Advantage

 A country has a comparative advantage where its cost of

production, measured in opportunity cost terms, is lowest.
 Equivalently, a country has a comparative advantage in whatever
product where either its absolute advantage is relatively greatest or
where its absolute disadvantage is relatively least.
Comparative Advantage

 Two countries can benefit from specializing (at least to some

extent) in the product where each has a comparative advantage
and then trading with each other.
 This statement holds true even if one of the countries has an
absolute advantage in both products !!
Mutually Beneficial Trade with Comparative Advantage (1 of 3)
Mutually Beneficial Trade with Comparative Advantage (2 of 3)

Point A
Mutually Beneficial Trade with Comparative Advantage (3 of 3)

Give up 1.25
Refrigerators per
Pair of Shoes: Point A
MEXICO MAKES
SHOES

USA’s PPP (from

previous slide)
Give up 4
Refrigerators per Pair
of Shoes:
USA MAKES
REFRIGERATORS
Comparative Advantage

Domestic Exchange
4 Refrigerators per
Pair of Shoes:
USA MAKES
REFRIGERATORS

Domestic Exchange
1.25 Refrigerators per
Pair of Shoes: MEXICO
MAKES SHOES

BEFORE Trade AFTER Trade

Comparative Advantage

4 1

1 0.8
Absolute versus Comparative Advantage: Summary of Alternative
Concepts

A Trading is mutually
B beneficial for two Allows a country
Describes ability of Intuitive “no-
S countries if each to produce a
a country to brainer”
O has an absolute higher volume of
L
produce goods at
advantage in one
justification for
a lower per unit goods with the
U product with international
cost given amount of
T respect to any pair trade
resources
E of tradable products

C
O
Allows a country
Trading is mutually to produce
M Counterintuitive
beneficial for two goods by giving
P Describes ability of concept that
countries if one has up less than
A a country to
a comparative justifies trade
R produce goods at
advantage in one
another nation
A a lower benefits without
product with with respect to
T opportunity cost absolute
respect to any pair any pair of
i advantage
of tradable products tradable
V
E
products

Adapted from: pediaa.com

Intra-industry Trade between Similar Economies

 A large share of global trade happens between high-income

economies that are quite similar in having well-educated workers and
advanced technology.
 These countries practice intra-industry trade, in which they import
and export the same products at the same time, like:
 Cars
 Machinery
 Computers
Intra-industry Trade between Similar Economies

 In the case of intra-industry trade between similar economies, gains

from trade come from:
 Specialized learning in very particular tasks
 Luxury versus mid-range cars
 Economies of Scale
 Farming Equipment versus Precision Tools
Economies of Scale
The Size of Benefits from International Trade

 The gains of international trade are very large, especially for

smaller countries but …
 … can be difficult to measure with precision.
From Interpersonal to International Trade

 As interpersonal, inter-community and interstate trade offers

economic gains, so too does international trade.
 International trade currently involves over $23 trillion worth of
goods and services thundering around the globe.
 Any economic force of that size, even if it confers overall
benefits, is certain to cause disruption and controversy.