Transcript Absolute Advantage, Comparative Advantage

Economic Perspectives
Chapter 17
Why trade?
• All trade is voluntary
• People trade because they believe that they will be
better off by trading
• The factors of production are not evenly distributed
throughout the world
– Natural resources are more plentiful in some areas
– Human capital is more skilled in nations with higher
literacy rates
– Physical capital is deeper in some nations
• Better machinery
• Infrastructure is better
How does specialization create a
need for trade?
– When nations specialize in certain goods, they
obtain the goods they cannot produce through
importing and exporting.
– In some cases, more than 70 percent of a
nation’s export trade depends upon a single
resource.
• Examples include Kuwait (petroleum and
natural gas), Guinea-Bissau (cashews), and
the Marshall Islands (fish).
Benefits from
Specialization and Trade
• Specialization and trade increase productivity and
the standard of living within a nation.
• Because of specialization and trade, there will be a
larger global output of goods and services.
• Everyone can benefit when people trade with one
another. Not only can people enjoy a greater
quantity of goods and services, but they can also
enjoy a greater variety of goods.
Absolute Advantage
• Most nations are not self-sufficient.
• It is actually better for countries to specialize
in some products and trade for others. This
can be understood by looking at absolute and
comparative advantage.
– A person or nation has an absolute
advantage when it can produce more of a
given product than another person or
nation using a given amount of resources.
Is Absolute Advantage the only basis
for trading?
What if a person or a nation has an
absolute advantage in producing
everything….would there still be a
reason to specialize and trade?
Comparative Advantage
• A country has a comparative advantage in the product
that it can produce most efficiently given all the
products it could choose to produce.
• A nation is better off when it produces goods and
services for which it has a comparative advantage.
– According to the law of comparative advantage,
each person should produce the good for which he
or she has a lower opportunity cost.
– Comparative advantage also mutually benefits both
parties.
Comparative Advantage and Trade
• Comparative advantage as the basis for trade is one of the
most important ideas in economics and also one of the least
intuitive
• Trade allows countries to obtain could for which they might
have a high opportunity cost.
– As a result, one country can use the money it earns from
exporting to import other goods and services that it cannot
efficiently produce itself.
• The growth of international trade has led to greater economic
interdependence.
– Because countries are interdependent, changes in one
country’s economy influences other countries.
Gains from Trade
• Gains from trade are based on comparative
advantage, not absolute advantage
• Specialization and trade increase productivity
within a nation and increase a nation’s output
and standard of living.
• Everyone can benefit when people trade with
one another. Not only can people enjoy a greater
quantity of goods and services, but they can also
enjoy a greater variety of goods.(faster economic
growth)
• Nations have strong trade relations that led to
increased political stability
So….if economists all
agree that free trade is
such a great idea, why do
so many people have
problems with the idea?
Barriers to Trade
• Tariffs- Tax on imported goods or services
• Reasons for tariffs
– Raise tax revenues
– Reduce consumption of the imported good or service
• Effect – Price of import rises, “cheaper” domestic
goods become more attractive
Quota
• Limits the amount of an imported good
allowed into the country
• Supply is decreased and price increases
• Voluntary Export Restrictions (VER’s) are
similar
Other Barriers to Trade
– Embargos-movement of goods
– Goods are subjected to health inspections
– Required to have a license to import
– Some nations use health issues to restrict
trade
– Nationalism and culture factors-some
countries prefer regional and traditional
foods to foods grown elsewhere
Arguments for Protection
• Protectionists claim that without trade barriers, a
country could become so specialized that it would
become too dependent on other countries, which
might result in severe shortages and even a decrease
in national security in time of war.
• The infant industries argument is that new or
emerging industries should be protected from
foreign competition until they are able to compete
against established industries in other countries.
• Protectionists claim that tariffs and quotas protect
domestic jobs from cheap foreign labor.
Arguments for Protection
• Protectionists claim that limiting imports will
keep American money in the United States.
• Protectionists believe that restrictions on
imports reduce trade deficits, helping the
balance of payments.
• Some countries protect certain products
because of national pride.
Trade Agreements
Trade agreements regulate international trade between two
or more nations. An agreement may cover all imports and
exports, certain categories of goods, or a single category.
The United States is currently engaged in some 320 trade
agreements with various nations.
• General Agreements on Tariffs and Trade
(GATT)
• North American Free Trade Agreement
(NAFTA)
• World Trade Organization
GATT
• “Provisional” agreement (1948 – 1994)
• Dramatic tariff reductions were negotiated in
a series of trade rounds
• Grew from 23 to 123 countries
•
•
•
•
WTO
WTO created in the Uruguay trade round
Established in Geneva in 1995
153 member countries
GATT was updated and still forms the legal
framework for WTO negotiations on the goods
trade
• A worldwide organization whose goal is freer
global trade and lower tariffs
NAFTA
• Created to eliminate all tariffs and barriers
in the region (Canada, Mexico, US)
• Ratified in 1994
• Although there has been much
controversy, NAFTA has increased trade
between the three nations
Foreign Exchange Rates and
Currency Valuations
• Exchange rate
– The rate at which the money of one country is traded
for the money of another
• Values fluctuate, or “float,” depending on supply and
demand for each currency in the international market.
• National governments deliberately influence exchange
rates
• Business transactions usually conducted in currency of
the region where they happen.
Copyright © 2013 Pearson Education, Inc.
publishing as Prentice Hall
3-20
Fixed Exchange Rates
• Fixed Exchange Rates:
– Monetary policy is useless.
– Fiscal policy is made stronger.
• To be successful, fixed exchange rates require consistency or
coordination in these areas.
– Multiple objectives within a country may require conflicting
policies, so priorities may be critically important.
– Independent monetary policies are not possible.
– Tax, interest rate, or inflation rate differences will lead to
capital flows that will undermine the currency fix.
– Productivity and productivity growth differences affect
relative inflation rates.
Floating Exchange Rates
• In a floating (flexible) exchange rate system,
the value of a country’s currency in terms of
other currencies can change depending on
world market conditions.
• Under a floating exchange rate system, there
is no government intervention to attempt to
keep the exchange rate at a specific value.
• Today, most of the world uses a floating
exchange rate system.
Copyright © 2005 Pearson
Addison-Wesley. All rights
reserved.
17-22
Trade Surpluses and Deficits
• When a country exports more than it
imports, it runs a trade surplus.
• A trade deficit is the situation when a
country imports more than it exports.
23 of 47
Value of Currency
•The trade-weighted value of the dollar is an
index that shows the strength of the dollar
against a group of major foreign currencies.
•When the dollar weakens, export industries
benefit and import industries suffer; the reverse
is true when the dollar strengthens.
•There is no net gain to the economy by having
either a strong or a weak dollar, because in either
case, while one sector of the economy is hurt,
another is helped.