Carlos Andres Rodriguez Herrera 2 1 23 Principles of Macroeconomics ECON 2002 01 Chapter 32 Comparative Advantage and the Open Economy Introduction In 2001 the U S government slashed tariffs which are taxes on items imported from other countries For the following 10 years the dollar value of cut flowers imported to the U S from Colombia quadrupled Californian flower growers responded by lobbying Congress to restore the original higher tariffs To understand how tariffs affect product price you need to learn about international trade which is the subject of this chapter Learning Objectives Discuss the worldwide importance of international trade Explain why nations can gain from specializing in production and engaging in international trade Understand common arguments against free trade Describe ways that nations restrict foreign trade Identify key international agreements and organizations that adjudicate trade disputes among nations Chapter Outline The Worldwide Importance of International Trade Why We Trade Comparative Advantage and Mutual Gains form Exchange The Relationship Between Imports and Exports International Competitiveness Arguments Against Free Trade Ways to Restrict Foreign Trade International Trade Organizations The Worldwide Importance of International Trade World GDP today is nearly nine times greater than it was at the end of World War II World trade has increased to more than 28 times what it was in 1950 The United States has figured prominently in this expansion of world trade Why We Trade Comparative Advantage and Mutual Gains from Exchange We have learned about the concept of specialization and the mutual gains from trade We can understand gains from trade among nations by understanding output gains from specialization between individuals Comparative Advantage Specialization among nations The ability to produce a good or service at a lower opportunity cost compared with producers The Ohio State University 1 To demonstrate the concept of comparative advantage consider a simple two country two good world Production and consumption capabilities in a two country two good world We show maximum feasible quantities of software and PCs Using all resources land labor capital and entrepreneurship U S residents can utilize all their resources to produce 90 units of software or 225 PC Residents of India are able to utilize all their resources to produce either 100 units of per hour software or 50 PCs per hour Comparative advantage The opportunity cost of producing a tablet is lower in the United States than in India a Cost of producing 1 tablet 0 4 apps b Cost of producing 1 app 2 5 tablets The opportunity cost of producing an app is lower in India than the United States a Cost of producing 1 tablet 2 apps b Cost of producing 1 app 0 5 tablets The United States and India will specialize in activities with which they experience a lower opportunity cost In other words they will specialize in the activity in which they have a comparative advantage Specialization in production United State will specialize produce 225 tablet devices and no apps India will specialize produce 100 apps and no tablet devices Consumption with specialization and trade The United States is willing to buy 1 digital app as long as they provide in exchange no more than 2 5 tablet devices This is the United State s opportunity cost of producing 1 digital app at home India buys a tablet device from the United States in exchange for no more than 2 digital apps This is India s opportunity cost of producing a tablet device at home The United States consumes 75 digital apps imported from India and consumes 150 tablet devices produced at home Indian residents consume 25 digital apps produced at home and import 75 tablet devices form the United States By specializing and engaging in trade Gains from trade The United States gain form specialization and trade is 45 digital apps India can consume 37 5 more tablet devices These are net gains Specialization is the key Specializing in producing goods for which a nation has a comparative advantage allows for greater efficiency Production capabilities increase making possible greater worldwide consumption through international trade Observations on specialization and trade Not everyone gains from trade Cannot run out of exports Every country will always have a comparative advantage in something Other benefits form international trade the transmission of ideas New goods services spread New processes transmitted Intellectual property introduced Carlos Andres Rodriguez Herrera 2 1 23 The Relationship Between Exports and Imports In the long run imports are paid for by exports Any restrictions on imports ultimately reduce exports When a country engages in trade it is not competing against the other countries All nations stand to benefit from trade International Competitiveness Questions Is the United States falling behind Do we need to stay competitive internationally What does global competitiveness really mean Answer The United States leads in overall productive efficiency according to the Institute for Management Development in Lausanne Switzerland Reasons for this ranking Widespread entrepreneurship Economic restructuring Investment in information technology Sophisticated financial system Large investments in scientific research Arguments Against Free Trade Infant Industry Argument The contention that tariffs should be imposed to protect from import competition an industry that is trying to get started Presumably after the industry become technologically efficient the tariff can be lifted Selling a good or a service abroad below the price charged in the home market or at a price below its cost of production Dumping Protecting domestic jobs Do imports reduce jobs a Gould Woodbridge Ruffin study no causal link between the rate of imports and unemployment b In half of the cases studied when imports rose unemployment fell The cost of protecting U S jobs Restrictions on textiles and apparel goods cost U S consumers 9 billion a year a Cost 50 000 a year for each 20 000 job saved Restrictions on imports of Japanese cars a Cost 160 000 per year for each job saved in the auto industry Glass industry restrictions Steel industry restrictions a Cost 200 000 per year per job saved a Cost 750 000 per year per job saved Emerging arguments against free trade Environmental concerns Genetic engineering New diseases National defense Exports of new technology The Ohio State University 3