CHAPTER 17

International Trade

1

Part Four: Microeconomics of Government and International

Economics

Slides prepared by Bruno Fullone,

George Brown College ©2010 McGraw-Hill Ryerson Ltd.

Chapter 17

2

In this chapter you will learn:

17.1 About specialization, comparative advantage,

and international trade

17.2 About supply and demand analysis of exports

and imports

17.3 About trade barriers and their negative effects on

nations’ economic well-being

3 LO 17.1

17.1The Economic Basis for Trade

Why do nations trade?

• The distribution of resources is uneven

• Efficient production requires different

technologies or resource combinations

• Products are differentiated as to quality

and other non-price attributes

LO 17.1 4

The Economic Basis for Trade

• Labour-intensive goods

• Land-intensive goods

• Capital-intensive goods

LO 17.1 5

Specialization and Comparative

Advantage

The Basic Principle

• Specialization according to comparative

advantage reduces costs

• Absolute advantage

LO 17.1 6

Specialization and Comparative

Advantage

Two isolated nations (Canada and Brazil)

1. Constant Costs

– Straight-line production possibilities curves

2. Different Costs

– Different technology and resources

3. Canada Has Absolute Advantage in Both

Steel and Soybeans

LO 17.1 7

So

yb

ea

ns

(to

nn

es

)

5 8 10 15 20

Canada Brazil

5 10 15 18 20 25 30

Steel (tonnes)

So

yb

ea

ns

(to

nn

es

)

A

30

25

20

15

12

10

5

0

18 steel

12 soybeans

30

25

20

15

10

4

0

B

8 steel

4 soybeans

Steel (tonnes)

Production Possibilities Curve Figure 17-1

LO 17.1 8

Opportunity Cost Table

Country 1 Steel Cost 1 Soybean

Cost

Canada 1 soybean 1 steel

Brazil 2 soybeans .5 steel

Who has the comparative advantage in steel?

Specialization Based on Comparative

Advantage

LO 17.1 9

Opportunity Cost Table

Country 1 Steel Cost 1 Soybean

Cost

Canada 1 soybean 1 steel

Brazil 2 soybeans .5 steel

Who has the comparative advantage in soy?

Specialization Based on Comparative

Advantage

10 LO 17.1

Terms of Trade

•What will the terms of trade be?

•Many possibilities

•For trade to be mutually beneficial the

terms of trade must be between each

nation’s opportunity costs

LO 17.1 11

Country 1 Steel Cost 1 Soybean Cost

Canada 1 soybean 1 steel

Brazil 2 soybeans .5 steel

Opportunity Cost Table

for example:

• 1 steel for 1.5 soybeans

• gains from trade can be illustrated with

trading possibilities line

Terms of Trade

LO 17.1 12

45

40

35

30

25

20

15

12

10

5

0

30

25

20

15

10

4

0

5 10 15 18 20 25 30 5 8 10 15 20

A

B

Canada Brazil

So

yb

ean

s (

ton

nes)

So

yb

ean

s (

ton

nes)

Steel (tonnes) Steel (tonnes)

Trading

possibilities

line Trading

possibilities

line

Trading Possibilities Lines and the Gains from

Trade

1.5 soy for 1

steel

.67 steel for

1 soy

Figure 17-2

13 LO 17.1

Table 17-1 Comparative Advantage and the Gains from

Trade

14 LO 17.1

Gains from Trade

•Improved Options

•Added Output

15 LO 17.1

Trade with Increasing Costs

A more realistic model:

Increasing opportunity costs

Less than complete specialization

16 LO 17.1

The Case for Trade Restated

•Through free trade based on the principle of

comparative advantage, the world economy can

achieve a more efficient allocation of resources

and a higher level of material well-being than

without free trade

•Side benefits:

•Promotion of competition; deterrence of monopoly

•Linking of national interests; reduction of national

animosities

17 LO 17.1

17.2 Supply and Demand Analysis of

Exports and Imports

•When world prices increase relative to

domestic prices, domestic exports will

increase, resulting in an upward

sloping export supply curve

•When world prices decrease relative

to domestic prices, domestic imports

will increase, resulting in a downward

sloping import demand curve

LO 17.2 18

Cdn. domestic aluminum market Cdn. export supply and

import demand

100 50

Sd

Dd

100 50 75 125 150

If the world price

exceeds the Cdn.

price by 25 cents...

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

$1.75

1.50

1.25

1.00

.75

$1.75

1.50

1.25

1.00

.75

Canadian Export Supply and Import Demand

Figure 17-3

LO 17.2

19 100 50

Sd

Dd

100 50 75 125 150

EXPORTS = 50 SURPLUS = 50

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Cdn. domestic aluminum market Cdn. export supply and

import demand

$1.75

1.50

1.25

1.00

.75

$1.75

1.50

1.25

1.00

.75

If the world price

goes further up...

Canadian Export Supply and Import Demand

LO 17.2

20 100 50

Sd

Dd

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

100 50 75 125 150

Cdn.

export

supply

SURPLUS = 100 EXPORTS = 100

Cdn. domestic aluminum market Cdn. export supply and

import demand

$1.75

1.50

1.25

1.00

.75

$1.75

1.50

1.25

1.00

.75

If world prices

fall below $1.25...

Canadian Export Supply and Import Demand

LO 17.2 21

100 50

Sd

Dd

100 50 75 125 150

Cdn.

export

supply

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Cdn. domestic aluminum market Cdn. export supply and

import demand

$1.75

1.50

1.25

1.00

.75

$1.75

1.50

1.25

1.00

.75

SHORTAGE = 50 IMPORTS = 50

Canadian Export Supply and Import Demand

LO 17.2

22 100 50

Sd

Dd

100 50 75 125 150

SHORTAGE = 100

Cdn.

import

demand

Cdn.

export

supply

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Cdn. domestic aluminum market Cdn. export supply and

import demand

$1.75

1.50

1.25

1.00

.75

$1.75

1.50

1.25

1.00

.75

IMPORTS = 100

Canadian Export Supply and Import Demand

LO 17.2 23

U.S. domestic aluminum market U.S. export supply and

import demand

$1.50

1.25

1.00

.75

.50

100 50

$1.50

1.25

1.00

.75

.50

Sd

Dd

100 50 75 125 150

SURPLUS = 50

SURPLUS = 100

U.S.

export

supply

EXPORTS = 50

EXPORTS = 100

SHORTAGE = 50 IMPORTS = 50

SHORTAGE = 100 IMPORTS = 100

U.S.

import

demand P

rice (

per

kg

. C

dn

. d

oll

ars

)

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

U.S. Export Supply and Import Demand Figure 17-4

LO 17.2 24

1.25

1.125

1.00

Pri

ce (

per

kg

. C

dn

. d

oll

ars

)

Cdn.

export

supply

Cdn.

import

demand

U.S.

export

supply

U.S.

import

demand

e

World price is where:

U.S. export supply

= Cdn. import

demand

25

Figure 17-5 Equilibrium World Price

and Quantity of Exports and Imports

25 LO 17.2

Equilibrium World Price, Exports, and Imports

•International equilibrium occurs when one nation’s import demand curve intersects another nation’s export supply curve

•Americans will pay more for aluminum with trade than without it

•Americans are willing to export aluminum to Canada because they can gain from the trade (to import other goods)

•Canadians pay less for aluminum with trade; Canadians gain from the trade

26 LO 17.3

17.3 Trade Barriers

•Tariffs

•Revenue tariffs

•Protective tariffs

•Import Quotas

•Nontariff Barriers (NTBs)

•Voluntary Export Restraints

(VERs)

The Economic Effects of a Tariff or Quota

Quantity

Pri

ce

0

Dd

Sd

Pd

q

Sd + Q

Pt

Pw

a b c d

27

Figure 17-6

LO 17.3

28 LO 17.3

Economic Impact of Tariffs

•Direct Effects:

•Decline in Consumption

•Increased Domestic Production

•Decline in Imports

•Tariff Revenue

•Indirect Effects:

•Expansion of inefficient industries at the expense of relatively efficient ones

29 LO 17.3

Economic Impact of Quotas

•The same, without the tariff revenue for the

government

•Foreign firms reap the benefit of higher

prices

30 LO 17.3

Net Costs of Tariffs and Quotas

•Consumer costs

•Price of imported product goes up

•Some consumers shift purchases from

imports to higher-priced domestic goods

•Prices of domestic goods rise

•Gains to protected industries and

workers come at the expense of

much greater losses for the entire

economy

31 Chapter 17

The Last Word: Fair Trade Products

•Fair Trade Standards set up to help keep dominant sellers

from low income countries from keeping most of the proceeds

•More is paid to producers if more is paid to workers

•Economists question approach as an economic development

strategy

•Economists agree that some of the efforts of fair-trade

advocates have succeeded in channeling sizable purchases

away from otherwise identical substitutes and toward fair-

trade goods.

•Removal of agricultural subsidies may be a better tool

Chapter 17

32

Chapter 17 Summary

17.1 The Economic Basis for Trade • The Law of Comparative Advantages

17.2 Supply and Demand Analysis of Exports and Imports

17.3 Trade Barriers