. 103
( 126 .)


Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 4
356 The United States in the World Economy

worker productivity, which gave the United States a major competitive edge”an
edge we still have, by the way.
Remember, where standards of living are concerned, it is absolute advantage, not
comparative advantage, that counts. The country that is most efficient in producing
every output can pay its workers more in every industry.

1. Countries trade for many reasons. Two of the most 7. Tariffs and quotas aim to protect a country™s industries
important are that differences in their natural resources from foreign competition. Such protection may some-
and other inputs create discrepancies in the efficiency times be advantageous to that country, but not if foreign
with which they can produce different goods, and that countries adopt tariffs and quotas of their own in
specialization offers greater economies of large-scale retaliation.
production. 8. From the point of view of the country that imposes
2. Voluntary trade will generally be advantageous to both them, tariffs offer at least two advantages over quotas:
parties in an exchange. This concept is one of our Ideas Some of the gains go to the government rather than to
for Beyond the Final Exam. foreign producers, and they provide greater incentive
for efficient production.
3. International trade is more complicated than trade
within a nation because of political factors, differing na- 9. When a nation eliminates protection in favor of free
tional currencies, and impediments to the movement of trade, some industries and their workers will lose out.
labor and capital across national borders. Equity then demands that these people and firms be
compensated in some way. The U.S. government offers
4. Two countries will gain from trade with each other if
protection from import surges and various forms of
each nation exports goods in which it has a comparative
trade adjustment assistance to help those workers and
advantage. Even a country that is inefficient across the
industries adapt to the new conditions.
board will benefit by exporting the goods in whose pro-
duction it is least inefficient. This concept is another of the 10. Several arguments for protectionism can, under the
Ideas for Beyond the Final Exam. right circumstances, have validity. They include the na-
tional defense argument, the infant-industry argument,
5. When countries specialize and trade, each can enjoy
and the use of trade restrictions for strategic purposes.
consumption possibilities that exceed its production
But each of these arguments is frequently abused.
11. Dumping will hurt certain domestic producers, but it
6. The “cheap foreign labor” argument ignores the princi-
benefits domestic consumers.
ple of comparative advantage, which shows that real
wages (which determine living standards) can rise in
both importing and exporting countries as a result of

“Cheap foreign labor” Absolute advantage 343 Trade adjustment assistance 351
argument 340 Comparative advantage 343 Infant-industry argument 352
Imports 340 Mercantilism 348 Strategic argument for
Exports 340 protection 353
Tariff 348
Specialization 341 Dumping 353
Quota 348
Mutual gains from trade 341 Export subsidy 349

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Chapter 17 357
International Trade and Comparative Advantage

1. The following table describes the number of yards of f. What can be said about the price at which trade will
cloth and barrels of wine that can be produced with a take place?
week™s worth of labor in England and Portugal. Assume 2. Suppose that the United States and Mexico are the only
that no other inputs are needed. two countries in the world and that labor is the only pro-
ductive input. In the United States, a worker can pro-
In England In Portugal duce 12 bushels of wheat or 2 barrels of oil in a day. In
Mexico, a worker can produce 2 bushels of wheat or
Cloth 8 yards 12 yards
4 barrels of oil per day.
Wine 2 barrels 6 barrels
a. What will be the price ratio between the two com-
a. If there is no trade, what is the price of wine in terms modities (that is, the price of oil in terms of wheat) in
of cloth in England? each country if there is no trade?
b. If there is no trade, what is the price of wine in terms b. If free trade is allowed and there are no transporta-
of cloth in Portugal? tion costs, which commodity would the United States
import? What about Mexico?
c. Suppose each country has 1 million weeks of labor
available per year. Draw the production possibilities c. In what range would the price ratio have to fall under
frontier for each country. free trade? Why?
d. Which country has an absolute advantage in the d. Picking one possible post-trade price ratio, show
production of which good(s)? Which country has a clearly how it is possible for both countries to benefit
comparative advantage in the production of which from free trade.
e. If the countries start trading with each other, which
country will specialize and export which good?

1. You have a dozen shirts and your roommate has six consequence, it exports more to Country B every year
pairs of shoes worth roughly the same amount of than it imports from Country B. After 100 years of this
money. You decide to swap six shirts for three pairs of arrangement, both countries are destroyed in an earth-
shoes. In financial terms, neither of you gains anything. quake. What were the advantages or disadvantages of
Explain why you are nevertheless both likely to be the surplus to Country A? To Country B?
better off. 6. Under current trade law, the president of the United
2. In the eighteenth century, some writers argued that one States must report periodically to Congress on countries
person in a trade could be made better off only by gain- engaging in unfair trade practices that inhibit U.S. ex-
ing at the expense of the other. Explain the fallacy in this ports. How would you define an “unfair” trade prac-
argument. tice? Suppose Country X exports much more to the
United States than it imports, year after year. Does that
3. Country A has a cold climate with a short growing sea-
constitute evidence that Country X™s trade practices are
son, but a highly skilled labor force (think of Finland).
unfair? What would constitute such evidence?
What sorts of products do you think it is likely to pro-
duce? What are the characteristics of the countries with 7. Suppose the United States finds Country X guilty of un-
which you would expect it to trade? fair trade practices and penalizes it with import quotas.
So U.S. imports from Country X fall. Suppose, further,
4. After the removal of a quota on sugar, many U.S. sugar
that Country X does not alter its trade practices in any
farms go bankrupt. Discuss the pros and cons of remov-
way. Is the United States better or worse off? What about
ing the quota in the short and long runs.
Country X?
5. Country A has a mercantilist government that believes it
is always best to export more than it imports. As a

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 4
358 The United States in the World Economy

| APPENDIX | Supply, Demand, and Pricing in World Trade
country, for that is how world supply and demand
As noted in the text, price determination in a world
market with free trade depends on supply and
demand conditions in each of the countries participat- 2. The price of wheat must be the same in both
ing in the market. This appendix works out some of the countries.6
details in a two-country example.
In Figure 3, these two conditions are met at a price of
When applied to international trade, the usual supply-
$2.50 per bushel. At that price, the distance AB between
demand model must deal with (at least) two demand
what the exporting country produces and what it con-
curves: that of the exporting country and that of the im-
sumes equals the distance CD between what the im-
porting country. In addition, it may also involve two sup-
porting country consumes and what it produces. This
ply curves, because the importing country may produce
means that the amount the exporting country wants to
part of its own consumption. (For example, the United
sell at $2.50 per bushel exactly equals the amount the
States, which is the world™s biggest importer of oil,
importing country wants to buy at that price.
nonetheless produces quite a bit of domestic oil.) Further-
At any higher price, producers in both countries
more, equilibrium does not take place at the intersection
would want to sell more and consumers in both coun-
point of either pair of supply-demand curves. Why? Be-
tries would want to buy less. For example, if the price
cause if the two countries trade at all, the exporting nation
rose to $3.25 per bushel, the exporter™s quantity sup-
must supply more than it demands while the importing
plied would rise from B to F and its quantity demanded
nation must demand more than it supplies.
would fall from A to E, as shown in Panel (a). As a re-
All three of these complications are illustrated in
sult, more wheat would be available for export”EF
Figure 3, which shows the supply and demand curves
rather than AB. For exactly the same reason, the price
of a country that exports wheat in Panel (a) and of a
increase would cause higher production and lower
country that imports wheat in Panel (b). For simplicity,
sales in the importing country, leading to a reduction in
we assume that these countries do not deal with any-
imports from CD to GH in Panel (b).
one else. Where will the two-country wheat market
But this means that the higher price, $3.25 per
reach equilibrium?
bushel, cannot be sustained in a free and competitive
Under free trade, the equilibrium price must satisfy
international market. With export supply EF far greater
two requirements:
than import demand GH, there would be pressure on
1. The quantity of wheat exported by one country must price to fall back toward the $2.50 equilibrium price.
equal the quantity of wheat imported by the other

F I GU R E 3
Supply-Demand Equilibrium in the International Wheat Trade

country™s Exporting
Price of Wheat per Bushel

Price of Wheat per Bushel

demand country™s


Exports Imports

Importing Importing
country™s country™s
supply demand
0 0
Quantity of Wheat Quantity of Wheat

(a) Exporting Country (b) Importing Country

To keep things simple, we ignore such details as the costs of ship-

ping wheat from one country to the other.

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Chapter 17 359
International Trade and Comparative Advantage

(point A). So its exports are 45 million bushels”the
Similar reasoning shows that no price below $2.50 can
distance AB. Similarly, the importing country con-
be sustained. Thus:
sumes 95 million bushels”point D in Panel (b)”and
In international trade, the equilibrium price is the one
produces only 50 million (point C), so its imports are
that makes the exporting country want to export exactly
also 45 million bushels”the distance CD.
the amount that the importing country wants to import.
Now suppose the government of the importing na-


. 103
( 126 .)