Using the Concept of Opportunity Cost: International Trade

1
Using the Concept of Opportunity Cost
International Trade

• Key terms
• Absolute advantage
• Comparative advantage
• Trade policy

2
A Model of Trade

• 2 countries
• Each country can produce 2 goods, e.g. movies and
  pizzas.
• Each country must decide how much of each good to
  produce and how much to consume.
• A country exports a good it produces more of than
  it wishes to consume.
• A country imports a good it produces less of than
  it wishes to consume.
• Countries seek to maximize "social welfare".

3
A Simple Example
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• Pizzas cost 10 each and movies cost 6 each.
  You have 60 per month to spend on pizzas and
  movies. Your roommate has 100 per month to
  spend on pizzas and movies.
• What would you do if you could buy pizzas for 8
  and your roommate could buy movies tickets for
  4?
• Who can buy more movies?
• Who can buy more pizzas?
• What is your marginal cost of buying a pizza?
• What is your roommate's marginal cost of buying a
  pizza?
• What is your marginal cost of buying a movie
  ticket?
• What is your roommate's marginal cost of buying a
  movie ticket?

4
Describing differences between countries

• Absolute advantage
• A country has an absolute advantage in producing
  a good if it can produce a product using fewer
  resources than other countries.
• Comparative advantage
• A country has a comparative advantage in
  producing a good if it has the lowest marginal
  cost of production.

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Trade is beneficial
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• Trade in the direction of comparative advantage
  creates economic wealth.
• Each partys PPF (or budget line) is pushed out.
  
• With the same set of resources, each party can do
  more.

6
Country A can produce up to 10 million board
feet of lumber each month or up to 4 million
bushels of corn per month. Country B can produce
up to 6 million board feet of lumber each month
or up to 3 million bushels of corn per month.
For both countries, the marginal cost of corn
production is a constant.

• Which country has a comparative advantage in
  producing corn and which country has an absolute
  advantage in producing corn?
• At what price will corn be traded?

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Increasing Marginal CostsDirection of Trade
Depends on Autarkic Choices
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Lumber
Country A
Country B
Corn
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Source of Comparative Advantage

• We need to think in terms of the inputs needed to
  produce each good.
• Some goods are produced using very labor
  intensive technologies.
• Some goods are produced using very capital
  intensive technologies.
• A country tends to have a comparative advantage
  producing a good for which it has a large
  endowment of the intensive factor.

9
If trade is good for both sides, why is there so
much opposition to free trade?

• Benefits are not distributed equally within a
  country
• Terms of trade

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Trade Barriers

• What are trade barriers?
• Tariffs
• Quotas
• Voluntary Export Restraints
• Domestic Content Restrictions
• Anti-dumping Regulations
• Labor and Environmental Standards
• Pollution Haven Hypothesis
• Domestic Tax Privileges and Subsidies
• Foreign Sales Corporation

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Trade Barriers

• Why do they exist if trade is beneficial?
• Increased trade forces firms and workers to be
  more competitive. There are adjustment costs.
• Few countries put equal weight on the benefits
  and costs that accrue to consumers, firms in the
  comparative advantage industries, and firms in
  the comparative disadvantage industries. Who do
  you think is going to apply the greatest
  political pressure?
• Trade laws U.S. vs. Australia

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Trade Agreements

• World Trade Organization (WTO)
• Predecessor was the General Agreement on Trade
  and Tariffs (GATT).
• Treaty is over 25,000 pages long.
• Membership gives countries Most Favored Nation
  status.
• Most developing countries have been allowed to
  open their markets gradually.
• NAFTA
• CAFTA

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Summary

• Trade in the direction of each country's
  comparative advantage is beneficial for both
  countries
• Terms of trade effects Determination of trade
  prices
• Incentives for trade barriers
• Trade agreements