Principles of Microeconomics Scarcity and Social Provisioning Chapter 26 International Trade

CHAPTER INTERNATIONAL TRADE INTRODUCTION TO INTERNATIONAL TRADE Figure . Apple or iPhone ?

While the iPhone is readily recognized as an Apple product , 26 of the component costs in it come from components made by rival , In international trade , there are often like this as each country or company focuses on what it does best . Credit modification of work by Creative Commons ) JUST WHOSE PHONE IS IT ?

The iPhone is a global product . Apple does not manufacture the iPhone components , nor does it assemble them . The assembly is done by Corporation , a Taiwanese company , at its factory in , China . But , the firm and competitor to Apple , actually supplies many of the parts that make up an 26 . That means , that is both the biggest supplier and biggest competitor for Apple . Why do these two firms work together to the iPhone ?

To understand the economic logic behind international trade , you have to accept , as these firms do , that trade is about mutually beneficial exchange . is one of the world largest electronics parts suppliers . Apple lets focus on making the best parts , which allows Apple to concentrate on its elegant products

PRINCIPLES or ECONOMICS 729 that are easy to use . If each company ( and by extension each country ) focuses on what it does best , there will be gains for all through trade . CHAPTER Introduction to International Trade In this chapter , you will learn about Absolute and Comparative Advantage What Happens When a Country Has an Absolute Advantage in All Goods Trade between Similar Economies The Benefits of Reducing Barriers to International Trade We live in a global marketplace . The food on your table might include fresh fruit from Chile , cheese from France , and bottled water from Scotland . Your wireless phone might have been made in or Korea . The clothes you wear might be designed in Italy and manufactured in China . The toys you give to a child might have come from India . The car you drive might come from Japan , Germany , or Korea . The gasoline in the tank might be refined from crude oil from Saudi Arabia , Mexico , or . As a worker , if your job is involved with farming , machinery , airplanes , cars , scientific , or many other industries , the odds are good that a hearty proportion of the sales of your hence the money that pays your from export sales . We are all linked by international trade , and the volume of that trade has grown dramatically in the last few decades . The first wave of globalization started in the nineteenth century and lasted up to the beginning of World War I . Over that time , global exports as a share of global rose from less than of in 1820 to of in 1913 . As the Nobel economist Paul of Princeton University wrote in 1995 It is a conceit that we invented the global economy just yesterday . In fact , world markets achieved an impressive degree of integration during the second half of the nineteenth century . Indeed , if one wants a specific date for the beginning of a truly global economy , one might well choose 1869 , the year in which both the Canal and the Union Pacific railroad were completed . By the eve of the First World War steamships and railroads had created markets for standardized commodities , like wheat and wool , that were fully global in their reach . Even the global flow of information was better than modern observers , focused on electronic technology , tend to realize the first submarine telegraph cable was laid under the Atlantic in 1858 , and by 1900 all of the worlds major economic regions could effectively communicate instantaneously . This first wave of globalization crashed to a halt in the beginning of the twentieth century . World War I severed many economic connections . During the Great Depression of the , many nations tried to fix their own economies by reducing foreign trade with others . World War II hindered international trade . Global flows of goods and financial capital rebuilt themselves only slowly after World War II . It was not until the early that global economic forces again became as important , relative to the size of the world economy , as they were before World War I .

ABSOLUTE AND COMPARATIVE ADVANTAGE LEARNING OBJECTIVES By the end of this section , you will be able to Define absolute advantage , comparative advantage , and opportunity costs Explain the gains of trade created when a country specializes he American statesman Benjamin Franklin ( once wrote No nation was ever ruined by Many economists would express their attitudes toward international trade in an even more positive manner . The evidence that international trade confers overall benefits on economies is pretty strong . Trade has accompanied economic growth in the United States and around the world . Many of the national economies that have shown the most rapid growth in the last few example , Japan , South Korea , China , and done so by dramatically orienting their economies toward international trade . There is no modern example of a country that has shut itself off from world trade and yet prospered . To understand the benefits of trade , or why we trade in the first place , we need to understand the concepts of comparative and absolute advantage . In 1817 , David Ricardo , a businessman , economist , and member of the British Parliament , wrote a treatise called On the Principles of Political Economy and Taxation . In this treatise , Ricardo argued that specialization and free trade benefit all trading partners , even those that may be relatively inefficient . To see what he meant , we must be able to distinguish between absolute and comparative advantage . A country has an absolute advantage in producing a good over another country if it uses fewer resources to produce that good . Absolute advantage can be the result of a country natural ment . For example , extracting oil in Saudi Arabia is pretty much just a matter of drilling a oil in other countries can require considerable exploration and costly technologies for drilling and indeed they have any oil at all . The United States has some of the richest land in the world , making it easier to grow corn and wheat than in many other countries . and Colombia have climates especially suited for growing coffee . Chile and have some of the worlds richest copper mines . As some have argued , geography is Chile will provide copper and will produce coffee , and they will trade . When each country has a product others need and it can be produced with fewer resources in one country over another , then it is easy to imagine all parties benefitting from trade . However , thinking about trade just in terms of geography and absolute advantage is incomplete . Trade really occurs because of comparative advantage . Recall from the chapter Choice in a World of Scarcity that a country has a comparative advantage when a good can be produced at a lower cost in terms of other goods . The question each country or

PRINCIPLES or ECONOMICS 731 company should be asking when it trades is this What do we give up to produce this good ?

It should be no surprise that the concept of comparative advantage is based on this idea of opportunity cost from Choice in a World of Scarcity . For example , if focuses its resources on producing per , its labor , land and financial resources can not be used to produce other goods such as corn . As a result , gives up the opportunity to produce corn . How do we quantify the cost in terms of other goods ?

Simplify the problem and assume that just needs labor to produce copper and corn . The companies that produce either copper or corn tell you that it takes 10 hours to mine a ton of copper and 20 hours to harvest a bushel of corn . This means the opportunity cost of producing a ton of copper is bushels of corn . The next section develops absolute and comparative advantage in greater detail and relates them to trade . Visit this website for a list of articles and podcasts pertaining to international trade topics . El I A NUMERICAL EXAMPLE OF ABSOLUTE AND COMPARATIVE ADVANTAGE Consider a hypothetical world with two countries , Saudi Arabia and the United States , and two , oil and corn . Further assume that consumers in both countries desire both these goods . These goods are homogeneous , meaning that producers can not differentiate between corn or oil from either country . There is only one resource available in both countries , labor hours . Saudi Arabia can produce oil with fewer resources , while the United States can produce corn with fewer resources . Table illustrates the advantages of the two countries , expressed in terms of how many hours it takes to produce one unit of each good . Country Oil ( hours per barrel ) Corn ( hours per bushel ) Saudi Arabia United States Table . How Many Hours It Takes to Produce Oil and Corn In Table , Saudi Arabia has an absolute advantage in the production of oil because it only takes an hour to produce a barrel of oil compared to two hours in the United States . The United States has an absolute advantage in the production of corn . To simplify , lets say that Saudi Arabia and the United States each have 100 worker hours ( see Table ) We illustrate what each country is capable of producing on its own using a production possibility frontier ( graph , shown in Figure . Recall from Choice in a World of Scarcity that the tion possibilities frontier shows the maximum amount that each country can produce given its resources , in this case workers , and its level of technology .

732 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Oil Production using 100 worker hours Corn Production using 100 Worker hours ry ( barrels ) bushels ) Saudi Arabia 100 or 25 United States 50 or 100 Table . Production Possibilities before Trade 110 50 100 A . 90 50 80 ?

70 60 30 . 40 20 . 30 20 lo . 10 . 10 20 30 20 30 40 50 60 70 80 90 Corn ( bushels ) Corn ( bushels ) a ) Saudi Arabia ( The United States Figure . Production Possibilities Frontiers . a ) Saudi Arabia can produce 100 barrels of oil at maximum and zero corn ( point A ) or 25 bushels of corn and zero oil ( point ) It can also produce other combinations of oil and corn if it wants to consume both goods , such as at point Here it chooses to consume 60 barrels of oil , leaving 40 work hours that can be allocated to producing 10 bushels of corn , using the data in Table . If the United States produces only oil , it can produce , at maximum , 50 barrels and zero corn ( point A ) or at the other extreme , it can produce a maximum of 100 bushels of corn and no oil ( point ) Other combinations of both oil and corn are possible , such as point . All points above the frontiers are impossible to produce given the current level of resources and technology . Arguably Saudi and consumers desire both oil and corn to live . Lets say that before trade occurs , both countries produce and consume at point or . Thus , before trade , the Saudi Arabian economy will devote 60 worker hours to produce oil , as shown in Table . Given the information in Table , this choice implies that it consumes 60 barrels of oil . With the remaining 40 worker hours , since it needs four hours to produce a bushel of corn , it can produce only 10 bushels . To be at point , the economy devotes 40 worker hours to produce 20 barrels of oil and the remaining worker hours can be allocated to produce 60 bushels of corn . Country Oil Production ( barrels ) Corn Production ( bushels ) Saudi Arabia ( 60 10 United States ( 20 60 Total World Production 80 70 Table . Production before Trade The slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn . Using all its resources , the United States can produce 50 barrels of oil or 100 bushels of

PRINCIPLES or ECONOMICS 733 corn . So the opportunity cost of one barrel of oil is two bushels of the slope is . Thus , in the production possibility frontier graph , every increase in oil production of one barrel implies a decrease of two bushels of corn . Saudi Arabia can produce 100 barrels of oil or 25 bushels of corn . The opportunity cost of producing one barrel of oil is the loss of of a bushel of corn that Saudi workers could otherwise have produced . In terms of corn , notice that Saudi Arabia gives up the least to produce a barrel of oil . These calculations are summarized in Table . Opportunity cost of one unit Oil ( in terms of Opportunity cost of one unit Corn ( in terms of corn ) oil ) Saudi Arabia United States Table . Opportunity Cost and Comparative Advantage Again recall that comparative advantage was defined as the opportunity cost of producing goods . Since Saudi Arabia gives up the least to produce a barrel of oil , 1414 22 in Table ) it has a advantage in oil production . The United States gives up the least to produce a bushel of corn , so it has a comparative advantage in corn production . In this example , there is symmetry between absolute and comparative advantage . Saudi Arabia needs fewer worker hours to produce oil ( absolute advantage , see Table ) and also gives up the least in terms of other goods to produce oil ( comparative advantage , see Table ) Such symmetry is not always the case , as we will show after we have discussed gains from trade fully . But first , read the following Clear It Up feature to make sure you understand why the line in the graphs is straight . CAN A PRODUCTION POSSIBILITY FRONTIER BE STRAIGHT ?

When you first met the production possibility frontier ( in the chapter on Choice in a World of Scarcity it was drawn with an shape . This shape illustrated that as inputs were transferred from producing one good to from education to health were increasing opportunity costs . In the examples in this ter , the are drawn as straight lines , which means that opportunity costs are constant . When a marginal unit of labor is transferred away from growing corn and toward producing oil , the decline in the quantity of corn and the increase in the quantity of oil is always the same . In reality this is possible only if the contribution of additional workers to output did not change as the scale of production changed . The linear production possibilities frontier is a less realistic model , but a straight line simplifies calculations . It also illustrates economic themes like absolute and comparative advantage just as clearly . GAINS FROM TRADE Consider the trading positions of the United States and Saudi Arabia after they have specialized and traded . Before trade , Saudi Arabia 60 barrels of oil and 10 bushels of corn . The United States consumes 20 barrels of oil and 60 bushels of corn . Given their current duction levels , if the United States can trade an amount of corn fewer than 60 bushels and receives in exchange an amount of oil greater than 20 barrels , it will gain from trade . With trade , the United States can consume more of both goods than it did without specialization and trade . Recall that the chapter Welcome to Economics ! defined specialization as it applies to workers and firms . tion is also used to describe the occurrence when a country shifts resources to focus on producing

734 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER a good that offers comparative advantage . Similarly , if Saudi Arabia can trade an amount of oil less than 60 barrels and receive in exchange an amount of corn greater than 10 bushels , it will have more of both goods than it did before specialization and trade . Table illustrates the range of trades that would benefit both sides . The US . Economy , after Specialization , Will Benefit The Saudi Arabian Economy , after Specialization , Will Benefit If It If It Exports no more than 60 bushels of corn Imports at least 10 bushels of corn Imports at least 20 barrels of oil Exports less than 60 barrels of oil Table . The Range of Trades That Benefit Both the United States and Saudi Arabia The underlying reason why trade benefits both sides is rooted in the concept of opportunity cost , as the following Clear It Up feature explains . Saudi Arabia wishes to expand domestic production of corn in a world without international trade , then based on its opportunity costs it must give up four barrels of oil for every one additional bushel of corn . Saudi Arabia could find a way to give up less than four barrels of oil for an additional bushel of corn ( or equivalently , to receive more than one bushel of corn for four barrels of oil ) it would be better off . WHAT ARE THE OPPORTUNITY COSTS AND GAINS FROM TRADE ?

The range of trades that will benefit each country is based on the country opportunity cost of producing each good . The United States can produce 100 bushels of corn or 50 barrels of oil . For the United States , the opportunity cost of producing one barrel of oil is two bushels of corn . If we divide the numbers above by 50 , we get the same ratio one barrel of oil is equivalent to two bushels of corn , or ( and ) In a trade with Saudi Arabia , if the United States is going to give up 100 bushels of corn in exports , it must import at least 50 barrels of oil to be just as well off . Clearly , to gain from trade it needs to be able to gain more than a half barrel of oil for its bushel of Why trade at all ?

Recall that David Ricardo argued that if each country specializes in its comparative advantage , it will benefit from trade , and total global output will increase . How can we show gains from trade as a result of comparative advantage and specialization ?

Table shows the output assuming that each country specializes in its comparative advantage and produces no other good . This is 100 specialization . Specialization leads to an increase in total world production . Compare the total world production in Table to that in Table . Quantity produced after 100 specialization Quantity produced after 100 specialization Country Oil ( barrels ) Corn ( bushels ) Saudi Arabia 100 United States 100 Total World Production 100 100 Table . How Specialization Expands Output What if we did not have complete specialization , as in Table ?

Would there still be gains from trade ?

Consider another example , such as when the United States and Saudi Arabia start at and , as shown in Figure . Consider what occurs when trade is allowed and the United States exports 20 bushels of corn to Saudi Arabia in exchange for 20 barrels of oil .

Oil ( barrels ) 735 PRINCIPLES OF ECONOMICS 100 90 ' 80 70 60 40 30 20 IO 10 20 Corn ( bushels ) 30 Figure . Production Possibilities Frontier in Saudi Arabia . Gains from trade of oil can increase only by achieving less from trade of corn . The opposite is true as well The more gains from trade of corn , the fewer gains from trade of oil . Starting at point , reduce Saudi Oil production by 20 and exchange it for 20 units of corn to reach point ( see Figure ) Notice that even without 100 specialization , if the trading price , in this case 20 barrels of oil for 20 bushels of corn , is greater than the country opportunity cost , the will gain from trade . Indeed both countries consume more of both goods after specialized production and trade occurs . Visit this Website for data . El . conga El

736 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER KEY CONCEPTS AND SUMMARY A country has an absolute advantage in those products in which it has a productivity edge over other countries it takes fewer resources to produce a product . A country has a comparative advantage when a good can be produced at a lower cost in terms of other goods . Countries that specialize based on comparative advantage gain from trade . SELF CHECK QUESTIONS . True or False The source of comparative advantage must be natural elements like climate and mineral deposits . Explain . Brazil can produce 100 pounds of beef or 10 autos in contrast the United States can produce 40 pounds of beef or 30 autos . Which country has the absolute advantage in beef ?

Which country has the absolute advantage in producing autos ?

What is the opportunity cost of producing one pound of beef in Brazil ?

What is the opportunity cost of producing one pound of beef in the United States ?

In France it takes one worker to produce one sweater , and one worker to produce one bottle of wine . In it takes two workers to produce one sweater , and three workers to produce one bottle of wine . Who has the absolute advantage in production of sweaters ?

Who has the absolute advantage in the production of wine ?

How can you tell ?

REVIEW QUESTIONS . What is absolute advantage ?

What is comparative advantage ?

Under what conditions does comparative advantage lead to gains from trade ?

What factors does Paul identify that supported the expansion of international trade in the ?

CRITICAL THINKING QUESTIONS Are differences in geography behind the differences in absolute advantages ?

Why does the United States not have an absolute advantage in coffee ?

Look at Question . Compute the opportunity costs of producing sweaters and wine in both France and . Who has the lowest opportunity cost of producing sweaters and who has the lowest opportunity cost of producing wine ?

Explain what it means to have a lower opportunity cost . PROBLEMS France and both have Mediterranean climates that are excellent for harvesting green beans and tomatoes . In France it takes two hours for each worker to harvest green beans and two hours to harvest a tomato . Tunisian workers need only one hour to harvest the tomatoes but four hours to harvest green beans . Assume there are only two workers , one in each country , and each works 40 hours a week .

PRINCIPLES OF ECONOMICS 737 Draw a production possibilities frontier for each country . Hint Remember the production possibility frontier is the maximum that all workers can produce at a unit of time which , in this problem , is a week . Identify which country has the absolute advantage in green beans and which country has the absolute advantage in tomatoes . Identify which country has the comparative advantage . How much would France have to give up in terms of tomatoes to gain from trade ?

How much would it have to give up in terms of green beans ?

REFERENCES , Paul Pop Internationalism . The MIT Press , Cambridge . 1996 . Paul What Do Undergrads Need to Know about Trade ?

American Economic Review 83 , 1993 . Ricardo , David . On the Principles of Political Economy and Taxation . London John Murray , 1817 . Ricardo , David . On the Principles of Political Economy and Library of Economics and . absolute advantage when one country can use fewer resources to produce a good compared to another country when a country is more productive compared to another country gain from trade a country that can consume more than it can produce as a result of specialization and trade SOLUTIONS Answers to Questions . False . Anything that leads to different levels of productivity between two economies can be a source of comparative advantage . For example , the education of workers , the knowledge base of engineers and scientists in a country , the part of a value chain where they have their specialized learning , economies of scale , and other factors can all determine comparative advantage . Brazil has the absolute advantage in producing beef and the United States has the absolute advantage in autos . The opportunity cost of producing one pound of beef is of an auto in the United States it is of an auto . In answering questions like these , it is often helpful to begin by organizing the information in a table , such as in the following table . Notice that , in this case , the productivity of the countries is expressed in terms of how many workers it takes to produce a unit of a product .

733 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Country One Sweater One Bottle of wine France worker I worker workers workers Table . In this example , France has an absolute advantage in the production of both sweaters and wine . You can tell because it takes France less labor to produce a unit of the good .

WHAT HAPPENS WHEN A COUNTRY HAS AN ABSOLUTE ADVANTAGE IN ALL GOODS LEARNING By the end of this section , you will be able to Show the relationship between production costs and comparative advantage Identify situations of mutually beneficial trade Identify trade benefits by considering opportunity costs hat happens to the possibilities for trade if one country has an absolute advantage in thing ?

This is typical for countries that often have workers , technologically advanced equipment , and the most production processes . These countries can produce all products with fewer resources than a country . If the country is more productive across the board , will there still be gains from trade ?

Good students of Ricardo understand that trade is about mutually beneficial exchange . Even when one country has an absolute advantage in all products , trade can still benefit both sides . This is because gains from trade come from specializing in ones comparative advantage . PRODUCTION POSSIBILITIES AND COMPARATIVE ADVANTAGE Consider the example of trade between the United States and Mexico described in Table . In this example , it takes four workers to produce pairs of shoes , but it takes five Mexican workers to do so . It takes one worker to produce refrigerators , but it takes four Mexican workers to do so . The United States has an absolute advantage in productivity with regard to both shoes and refrigerators that is , it takes fewer workers in the United States than in Mexico to produce both a given number of shoes and a given number of refrigerators . Count Number of Workers needed to produce Number of Workers needed to produce units ry units Shoes Refrigerators United States workers Worker Mexico workers workers Table . Resources Needed to Produce Shoes and Refrigerators Absolute advantage simply compares the productivity of a worker between countries . It answers the question , How many inputs do I need to produce shoes in Mexico ?

Comparative advantage asks this 740 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER same question slightly differently . Instead of comparing how many workers it takes to produce a good , it asks , How much am I giving up to produce this good in this country ?

Another way of looking at this is that comparative advantage identifies the good for which the producers absolute advantage is relatively larger , or where the producers absolute productivity disadvantage is relatively smaller . The United States can produce shoes with as many workers as Mexico ( four versus five ) but it can produce refrigerators with only as many workers ( one versus four ) So , the comparative advantage of the United States , where its absolute productivity advantage is relatively greatest , lies with refrigerators , and Mexico comparative advantage , where its absolute productivity disadvantage is least , is in the production of shoes . MUTUALLY BENEFICIAL TRADE WITH COMPARATIVE ADVANTAGE When nations increase production in their area of comparative advantage and trade with each other , both countries can benefit . Again , the production possibility frontier is a useful tool to visualize this benefit . Consider a situation where the United States and Mexico each have 40 workers . For example , as Table shows , if the United States divides its labor so that 40 workers are making shoes , then , since it takes four workers in the United States to make shoes , a total of shoes will be produced . If four workers can make shoes , then 40 workers will make shoes ) If the 40 workers in the United States are making refrigerators , and each worker can produce refrigerators , then a total of refrigerators will be produced . Country Shoe Production using 40 workers Refrigerator Production using 40 workers United States shoes or refrigerators Mexico shoes or refrigerators Table . Production Possibilities before Trade with Complete Specialization As always , the slope of the production possibility frontier for each country is the opportunity cost of one refrigerator in terms of foregone shoe labor is transferred from producing the latter to producing the former ( see Figure ) Lets say that , in the situation before trade , each nation prefers to produce a combination of shoes and refrigerators that is shown at point A . Table 10 shows the output of each good for each country and the total output for the two countries . Country Current Shoe Production Current Refrigerator Production United States Mexico Total Table 10 . Total Production at Point A before Trade Continuing with this scenario , each country transfers some amount of labor toward its area of advantage . For example , the United States transfers six workers away from shoes and toward producing refrigerators . As a result , production of shoes decreases by units ( while its production of refrigerators increases by ( that is , Mexico also moves duction toward its area of comparative advantage , transferring 10 workers away from refrigerators

PRINCIPLES or ECONOMICS 741 III A 6000 ( 4000 . 40000 50000 Refrigerators Refrigerators ( a ) 40 workers ) 40 workers ) Figure . Production Possibility Frontiers . a ) With 40 workers , the United States can produce either shoes and zero refrigerators or refrigerators and zero shoes . With 40 workers , Mexico can produce a maximum of shoes and zero refrigerators , or refrigerators and zero shoes . All other points on the production possibility line are possible combinations of the two goods that can be produced given current resources . Point A on both graphs is where the countries start producing and consuming before trade . Point is where they end up after trade . and toward production of shoes . As a result , production of refrigerators in Mexico falls by ( but production of shoes increases by pairs ( Notice that when both countries shift production toward each of their comparative advantages ( what they are relatively ter at ) their combined production of both goods rises , as shown in Table 11 . The reduction of shoe production by pairs in the United States is more than offset by the gain of pairs of shoes in Mexico , while the reduction of refrigerators in Mexico is more than offset by the additional refrigerators produced in the United States . Country Shoe Production Refrigerator Production United States Mexico Total Table 11 . Shifting Production Toward Comparative Advantage Raises Total Output This numerical example illustrates the remarkable insight of comparative advantage even when one country has an absolute advantage in all goods and another country has an absolute disadvantage in all goods , both countries can still benefit from trade . Even though the United States has an absolute advantage in producing both refrigerators and shoes , it makes economic sense for it to specialize in the good for which it has a comparative advantage . The United States will export refrigerators and in return import shoes .

742 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER HOW OPPORTUNITY COST SETS THE BOUNDARIES OF TRADE This example shows that both parties can benefit from specializing in their comparative advantages and trading . By using the opportunity costs in this example , it is possible to identify the range of trades that would benefit each country . Mexico started out , before specialization and trade , producing pairs of shoes and ( see Figure and Table 10 ) Then , in the numerical example given , Mexico shifted production toward its comparative advantage and produced pairs of shoes but only refrigerators . Thus , if Mexico can export no more than pairs of shoes ( giving up pairs of shoes ) in exchange for imports of at least refrigerators ( a gain of refrigerators ) it will be able to consume more of both goods than before trade . Mexico will be unambiguously better off . the United States started off , before specialization and trade , producing pairs of shoes and refrigerators . In the example , it then shifted production toward its comparative advantage , producing only shoes but refrigerators . If the United States can export no more than refrigerators in exchange for imports of at least pairs of shoes , it will be able to consume more of both goods and will be unambiguously better off . The range of trades that can benefit both nations is shown in Table 12 . For example , a trade where the exports refrigerators to Mexico in exchange for pairs of shoes would benefit both sides , in the sense that both countries would be able to consume more of both goods than in a world without trade . The US . economy , after specialization , will benefit if it The Mexican economy , after specialization , will benefit if it Exports fewer than refrigerators Imports at least refrigerators Imports at least pairs of shoes Exports no more than pairs of shoes Table 12 . The Range of Trades That Benefit Both the United States and Mexico Trade allows each country to take advantage of lower opportunity costs in the other country . If wants to produce more refrigerators without trade , it must face its domestic opportunity costs and reduce shoe production . If Mexico , instead , produces more shoes and then trades for refrigerators made in the United States , where the opportunity cost of producing refrigerators is lower , Mexico can in effect take advantage of the lower opportunity cost of refrigerators in the United States . when the United States specializes in its comparative advantage of refrigerator production and trades for shoes produced in Mexico , international trade allows the United States to take of the lower opportunity cost of shoe production in Mexico . The theory of comparative advantage explains why countries trade they have different comparative advantages . It shows that the gains from international trade result from pursuing comparative and producing at a lower opportunity cost . The following Work It Out feature shows how to absolute and comparative advantage and the way to apply them to a country production . CALCULATING ABSOLUTE AND COMPARATIVE ADVANTAGE In Canada a worker can produce 20 barrels of oil or 40 tons of lumber . In Venezuela , a worker can produce 60 barrels of oil or 30 tons of lumber .

PRINCIPLES or ECONOMICS 743 Country Oil ( barrels ) Lumber ( tons ) Canada 20 or 40 Venezuela 60 or 30 Table Who has the absolute advantage in the production of oil or lumber ?

How can you tell ?

Which country has a comparative advantage in the production of oil ?

Which country has a comparative advantage in producing lumber ?

In this example , is absolute advantage the same as comparative advantage , or not ?

In what product should Canada specialize ?

In what product should Venezuela specialize ?

Step . Make a table like Table 13 . Step . To calculate absolute advantage , look at the larger of the numbers for each product . One Worker in Canada can more lumber ( 40 tons versus 30 tons ) so Canada has the absolute advantage in lumber . One worker in Venezuela can produce 60 barrels of oil compared to a worker in Canada who can produce only 20 . Step . To calculate comparative advantage , find the opportunity cost of producing one barrel of oil in both countries . The country with the lowest opportunity cost has the comparative advantage . With the same labor time , Canada can produce either 20 barrels of oil or 40 tons of lumber . So in effect , 20 barrels of oil is equivalent to 40 tons of lumber 20 oil 40 lumber . Divide both sides of the equation by 20 to calculate the opportunity cost of one barrel of oil in Canada . oil lumber . oil lumber . To produce one additional barrel of oil in Canada has an opportunity cost of lumber . Calculate the same way for Venezuela 60 oil 30 lumber . Divide both sides of the equation by 60 . One oil in Venezuela has an opportunity cost of lumber . Because lumber lumber , Venezuela has the comparative advantage in producing oil . Step . Calculate the opportunity cost of one lumber by reversing the numbers , with lumber on the left side of the equation . In Canada , 40 lumber is equivalent in labor time to 20 barrels of oil 40 lumber 20 oil . Divide each side of the equation by 40 . The opportunity cost of one lumber is oil . In Venezuela , the equivalent labor time will produce 30 lumber or 60 oil 30 lumber 60 oil . Divide each side by 30 . One lumber has an opportunity cost of two oil . Canada has the lower opportunity cost in producing lumber . Step . In this example , absolute advantage is the same as comparative advantage . Canada has the absolute and comparative advantage in lumber Venezuela has the absolute and comparative advantage in oil . Step . Canada should specialize in what it has a relative lower opportunity cost , which is lumber , and Venezuela should specialize in oil . Canada will be exporting lumber and importing oil , and Venezuela will be exporting oil and importing lumber . COMPARATIVE ADVANTAGE GOES CAMPING To build an intuitive understanding of how comparative advantage can benefit all parties , set aside examples that involve national economies for a moment and consider the situation of a group of friends who decide to go camping together . The six friends have a wide range of skills and , but one person in particular , Jethro , has done lots of camping before and is also a great athlete . Jethro has an absolute advantage in all aspects of camping he is faster at carrying a backpack , ing firewood , paddling a canoe , setting up tents , making a meal , and washing up . So here is the tion has an absolute productivity advantage in everything , should he do all the work ?

Of course not ! Even if Jethro is willing to work like a mule while everyone else sits around , he , like most mortals , only has 24 hours in a day . If everyone sits around and waits to do everything , 744 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER not only will Jethro be an unhappy camper , but there will not be much output for his group of six friends to consume . The theory of comparative advantage suggests that everyone will benefit if they figure out their areas of comparative is , the area of camping where their productivity disadvantage is least , compared to Jethro . For example , it may be that Jethro is 80 faster at building fires and cooking meals than anyone else , but only 20 faster at gathering firewood and 10 faster at setting up tents . In that case , Jethro should focus on building fires and making meals , and others should attend to the other tasks , each according to where their productivity disadvantage is smallest . If the campers coordinate their efforts according to comparative advantage , they can all gain . KEY CONCEPTS AND SUMMARY Even when a country has high levels of productivity in all goods , it can still benefit from trade . Gains from trade come about as a result of comparative advantage . By specializing in a good that it gives up the least to produce , a country can produce more and offer that additional output for sale . If other countries specialize in the area of their comparative advantage as well and trade , the highly tive country is able to benefit from a lower opportunity cost of production in other countries . SELF CHECK QUESTIONS In Germany it takes three workers to make one television and four Workers to make one video camera . In Poland it takes six workers to make one television and 12 workers to make one video camera . a . Who has the absolute advantage in the production of televisions ?

Who has the absolute advantage in the production of video cameras ?

How can you tell ?

Calculate the opportunity cost of producing one additional television set in Germany and in Poland . Your calculation may involve fractions , which is fine . Which country has a comparative advantage in the production of televisions ?

Calculate the opportunity cost of producing one video camera in Germany and in Poland . Which country has a comparative advantage in the production of video cameras ?

In this example , is absolute advantage the same as comparative advantage , or not ?

In what product should Germany specialize ?

In what product should Poland specialize ?

REVIEW QUESTIONS . Is it possible to have a comparative advantage in the production of a good but not to have an absolute advantage ?

Explain . How does comparative advantage lead to gains from trade ?

CRITICAL THINKING QUESTIONS . You just overheard your friend say the following Poor countries like have no absolute advantages .

PRINCIPLES OF ECONOMICS 745 They have poor soil , low investments in formal education and hence workers , no capital , and no natural resources to speak of . Because they have no advantage , they can not benefit from trade . How would you respond ?

Look at Table 10 . Is there a range of trades for which there will be no gains ?

You just got a job in Washington , You move into an apartment with some acquaintances . All your roommates , however , are slackers and do not clean up after themselves . You , on the other hand , can clean faster than each of them . You determine that you are 70 faster at dishes and 10 faster with vacuuming . All of these tasks have to be done daily . Which jobs should you assign to your roommates to get the most free time overall ?

Assume you have the same number of hours to devote to cleaning . Now , since you are faster , you seem to get done quicker than your roommate . What sorts of problems may this create ?

Can you imagine a analogy to this problem ?

one worker can make tons of rubber or 80 radios . In Malaysia , one worker can make 10 tons of rubber or 40 radios . a . Who has the absolute advantage in the production of rubber or radios ?

How can you tell ?

Calculate the opportunity cost of producing 80 additional radios and in Malaysia . Your calculation may involve fractions , which is fine . Which country has a comparative advantage in the production of radios ?

Calculate the opportunity cost of producing 10 additional tons of rubber and in Malaysia . Which country has a comparative advantage in producing rubber ?

In this example , does each country have an absolute advantage and a comparative advantage in the same good ?

In what product specialize ?

In what product should Malaysia specialize ?

Review the numbers for Canada and Venezuela from Table 13 which describes how many barrels of oil and tons of lumber the workers can produce . Use these numbers to answer the rest of this question . a . Draw a production possibilities frontier for each country . Assume there are 100 workers in each country . Canadians and Venezuelans desire both oil and lumber . Canadians want at least tons of lumber . Mark a point on their production possibilities where they can get at least tons . Assume that the Canadians specialize completely because they figured out they have a comparative advantage in lumber . They are willing to give up tons of lumber . How much oil should they ask for in return for this lumber to be as well off as they were with no trade ?

How much should they ask for if they want to gain from trading with Venezuela ?

Note We can think of this ask as the relative price or trade price of lumber . Is the Canadian ask you identified in ( also beneficial for Venezuelans ?

Use the production possibilities frontier graph for Venezuela to show that Venezuelans can gain from trade . In Problem , is there an ask where Venezuelans may say no thank you to trading with Canada ?

746 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER REFERENCES , William A Splendid Exchange How Trade Shaped the World . Atlantic Monthly Press . New York . 2008 . SOLUTIONS Answers to Questions In Germany , it takes fewer workers to make either a television or a video camera . Germany has an absolute advantage in the production of both goods . Producing an additional television in Germany requires three workers . Shifting those three German Workers will reduce video camera production by of a camera . Producing an additional television set in Poland requires six workers , and shifting those Workers from the other good reduces output of video cameras by of a camera , or . Thus , the opportunity cost of producing televisions is lower in Poland , so Poland has the comparative advantage in the production of televisions . Note Do not let the fractions like of a camera or of a video camera bother you . If either country was to expand television production by a significant is , lots more than one We will be talking about whole cameras and not fractional ones . You can also spot this conclusion by noticing that Poland absolute disadvantage is relatively lower in televisions , because Poland needs twice as many workers to produce a television but three times as many to produce a video camera , so the product with the relatively lower absolute disadvantage is Poland comparative advantage . Producing a video camera in Germany requires four workers , and shifting those four workers away from television production has an opportunity cost of television sets . Producing a video camera in Poland requires 12 Workers , and shifting those 12 workers away from television production has an opportunity cost of two television sets . Thus , the opportunity cost of producing video cameras is lower in Germany , and video cameras will be Germany comparative advantage . In this example , absolute advantage differs from comparative advantage . Germany has the absolute advantage in the production of both goods , but Poland has a comparative advantage in the production of televisions . Germany should specialize , at least to some extent , in the production of video cameras , export video cameras , and import televisions . Conversely , Poland should specialize , at least to some extent , in the production of televisions , export televisions , and import video cameras .

TRADE BETWEEN SIMILAR ECONOMIES LEARNING OBJECTIVES By the end of this section , you will be able to Identify at least two advantages of trading Explain the relationship between economies of scale and trade and comparative advantages explain a great deal about patterns of global trade . For example , they help to explain the patterns noted at the start of this chapter , like why you may be eating fresh fruit from Chile or Mexico , or why lower productivity regions like Africa and Latin America are able to sell a substantial proportion of their exports to higher productivity regions like the European Union and North America . Comparative advantage , however , at least at first glance , does not seem especially to explain other common patterns of international trade . THE PREVALENCE OF TRADE BETWEEN SIMILAR ECONOMIES The theory of comparative advantage suggests that trade should happen between economies with large differences in opportunity costs of production . Roughly half of all world trade involves shipping goods between the fairly similar economies of the United States , Canada , the European Union , Japan , Mexico , and China ( see Table 14 ) Country Exports Go to Imports Come from European Union 190 210 Canada 220 140 Japan 60 Mexico 130 China Table 14 . Where Exports Go and US . Imports Originate ( 2015 ) Source , press , Moreover , the theory of comparative advantage suggests that each economy should specialize to a degree in certain products , and then exchange those products . A high proportion of trade , however , is is , trade of goods within the same industry from one country to another . For example , the United States produces and exports autos and imports autos . Table 15 shows some of the largest categories of exports and imports . In all of these categories , the United States is both

743 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER a substantial exporter and a substantial importer of goods from the same industry . In 2014 , ing to the Bureau of Economic Analysis , the United States exported 159 billion worth of autos , and imported 327 billion worth of autos . About 60 of trade and 60 of European trade is industry trade . Some Exports Quantity of Exports ( billions ) Quantity of Imports ( billions ) Autos 146 327 Food and beverages 144 126 Capital goods 550 551 Consumer goods 199 558 Industrial supplies 507 665 Other transportation 45 55 Table 15 . Some Exports and Imports in 2014 ( Source ) Why do similar economies engage in trade ?

What can be the economic benefit of having workers of fairly similar skills making cars , computers , machinery and other which are then shipped across the oceans to and from the United States , the European Union , There are two reasons ( The division of labor leads to learning , innovation , and unique skills and ( economies of scale . GAINS FROM SPECIALIZATION AND LEARNING Consider the category of machinery , where the economy has considerable trade . Machinery comes in many varieties , so the United States may be exporting machinery for with wood , but importing machinery for photographic processing . The underlying reason why a country like the United States , Japan , or Germany produces one kind of machinery rather than another is usually not related to , German , firms and workers having generally higher or lower skills . It is just that , in working on very specific and particular products , firms in certain countries develop unique and different skills . Specialization in the world economy can be very finely split . In fact , recent years have seen a trend in international trade called splitting up the value chain . The value chain describes how a good is in stages . As indicated in the beginning of the chapter , the production of the iPhone involves the design and engineering of the phone in the United States , parts supplied from Korea , the assembly of the parts in China , and the advertising and marketing done in the United States . Thanks in large part to improvements in communication technology , sharing information , and transportation , it has become easier to split up the value chain . Instead of production in a single large factory , all of these steps can be split up among different firms operating in different places and even different tries . Because firms split up the value chain , international trade often does not involve whole finished products like automobiles or refrigerators being traded between nations . Instead , it involves shipping more specialized goods like , say , automobile or the shelving that fits inside refrigerators . trade between similar countries produces economic gains because it allows workers and firms to learn and innovate on particular often to focus on very particular parts of the value chain .

PRINCIPLES or ECONOMICS 749 Visit this Website for some interesting information about the assembly of the iPhone . El El ECONOMIES OF SCALE , COMPETITION , VARIETY A second broad reason that trade between similar nations produces economic gains involves economies of scale . The concept of economies of scale , as introduced in Cost and Industry Structure , means that as the scale of output goes up , average costs of production least up to a point . Figure illustrates economies of scale for a plant producing toaster ovens . The horizontal axis of the figure shows the quantity of production by a certain firm or at a certain manufacturing plant . The vertical axis measures the average cost of production . Production plant produces a small level of output at 30 units and has an average cost of production of 30 per toaster oven . Plant duces at a medium level of output at 50 units , and has an average cost of production of 20 per toaster oven . Plant produces 150 units of output with an average cost of production of only 10 per toaster oven . Although plant can produce 200 units of output , it still has the same unit cost as Plant In this example , a small or medium plant , like or , will not be able to compete in the market with a large or a very large plant like or , because the firm that operates or will be able to produce and sell their output at a lower price . In this example , economies of scale operate up to point , but beyond point to , the additional scale of production does not continue to reduce average costs of production . The concept of economies of scale becomes especially relevant to international trade when it enables one or two large producers to supply the entire country . For example , a single large automobile tory could probably supply all the cars purchased in a smaller economy like the United Kingdom or Belgium in a given year . However , if a country has only one or two large factories producing cars , and no international trade , then consumers in that country would have relatively little choice between kinds of cars ( other than the color of the paint and other nonessential options ) Little or no tion will exist between different car manufacturers . International trade provides a way to combine the lower average production costs that come from economies of scale and still have competition and variety for consumers . Large automobile factories in different countries can make and sell their products around the world . If the automobile ket was made up of only General Motors , Ford , and Chrysler , the level of competition and choice would be quite a lot lower than when carmakers must face competition from , Honda , Suzuki , Fiat , Volkswagen , Kia , Subaru , and ers . Greater competition brings with it innovation and responsiveness to what consumers want . America car producers make far better cars now than they did several decades ago , and much of the reason is competitive pressure , especially from East Asian and European carmakers .

750 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER A , Average Cost of Production ( 30 50 100 ISO 200 250 Quantity of Production Figure . Economies of Scale . Production Plant , has an average cost of production of 30 per toaster oven . Production plant has an average cost of production of 20 per toaster oven . Production plant has an average cost of production of only 10 per toaster oven . Production plant would still have an average cost of production of 10 per toaster oven . Thus , production plant can produce toaster ovens more cheaply than plant because of economies of scale , and plants or can produce more cheaply than or because of economies of scale . However , the economies of scale end at an output level of 150 . Plant , despite being larger , can not produce more cheaply on average than plant DYNAMIC COMPARATIVE ADVANTAGE The sources of gains from trade between similar , the learning that comes from a high degree of specialization and splitting up the value chain and from economies of not contradict the earlier theory of comparative advantage . Instead , they help to broaden the concept . In trade , the level of worker productivity is not determined by climate or geography . It is not even determined by the general level of education or skill . Instead , the level of worker is determined by how firms engage in specific learning about specialized products , including taking advantage of economies of scale . In this vision , comparative advantage can be is , it can evolve and change over time as new skills are developed and as the value chain is split up in new ways . This line of thinking also suggests that countries are not destined to have the same advantage forever , but must instead be in response to ongoing changes in comparative advantage . KEY CONCEPTS AND SUMMARY A large share of global trade happens between economies that are quite similar in having workers and advanced technology . These countries practice trade , in

PRINCIPLES OF ECONOMICS 751 which they import and export the same products at the same time , like cars , machinery , and ers . In the case of trade between economies with similar income levels , the gains from trade come from specialized learning in very particular tasks and from economies of scale . Splitting up the value chain means that several stages of producing a good take place in different countries around the World . SELF CHECK QUESTIONS . How can there be any economic gains for a country from both importing and exporting the same good , like cars ?

Table 16 shows how the average costs of production for semiconductors ( the chips in computer memories ) change as the quantity of semiconductors built at that factory increases . a Based on these data , sketch a curve with quantity produced on the horizontal axis and average cost of production on the vertical axis . How does the curve illustrate economies of scale ?

If the equilibrium quantity of semiconductors demanded is , can this economy take full advantage of economies of scale ?

What about if quantity demanded is semiconductors ?

semiconductors ?

semiconductors ?

Explain how international trade could make it possible for even a small economy to take full advantage of economies of scale , while also benefiting from competition and the variety offered by several producers . Quantity of Semiconductors Average Total Cost each each each each each Table REVIEW QUESTIONS What is trade ?

What are the two main sources of economic gains from trade ?

What is splitting up the value chain ?

CRITICAL THINKING QUESTIONS Does trade contradict the theory of comparative advantage ?

Do consumers benefit from trade ?

Why might trade seem surprising from the point of view of comparative advantage ?

752 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER PROBLEMS . From earlier chapters you will recall that technological change shifts the average cost curves . Draw a graph showing how technological change could trade . Consider two countries South Korea and . can produce one million mobile phones per day at the cost of 10 per phone and South Korea can produce 50 million mobile phones at per phone . Assume these phones are the same type and quality and there is only one price . What is the minimum price at which both countries will engage in trade ?

REFERENCES Census Bureau . 2015 . International Trade in Goods and Services December Accessed April 13 , Census Bureau . Bureau of Economic Analysis . 2015 . International Trade in Goods and Services February Accessed April 10 , What Do Undergraduates Really Need to Know About Trade and Finance ?

in Political Economy and Contemporary Capitalism Radical Perspectives on Economic Theory and Policy , ed . Ron , Heather , and Dawn Saunders . Sharpe Inc , 2000 . trade international trade of goods within the same industry splitting up the value chain many of the different stages of producing a good happen in different geographic locations value chain how a good is produced in stages SOLUTIONS Answers to Questions . There are a number of possible advantages of trade . Both nations can take advantage of extreme specialization and learning in certain kinds of cars with certain traits , like cars , luxury cars , vehicles , and cars , and so on . Moreover , nations can take advantage of economies of scale , so that large companies will compete against each other across international borders , providing the benefits of competition and variety to customers . This same argument applies to trade between states , where people often buy products made by people of other states , even though a similar product is made Within the boundaries of their own state . All all benefit from this kind of competition and trade . a . Start by plotting the points on a sketch diagram and then drawing a line through them . The following figure illustrates the average costs of production of semiconductors .

PRINCIPLES OF ECONOMICS 753 36 ( 03 ) 32 I I I 10 20 30 40 50 60 70 80 90 100 Quantity of Production ( in thousands ) Figure . The curve illustrates economies of scale by showing that as the scale is , as tion at this particular factory goes average cost of production declines . The economies of scale exist up to an output of semiconductors at higher outputs , the average cost of duction does not seem to decline any further . At any quantity demanded above , this economy can take full advantage of economies of scale that is , it can produce at the lowest cost per unit . Indeed , if the quantity demanded was quite high , like , then there could be a number of different factories all taking full advantage of economies of scale and competing with each other . If the quantity demanded falls below , then the economy by itself , without foreign trade , can not take full advantage of economies of scale . The simplest answer to this question is that the small country could have a large enough factory to take full advantage of economies of scale , but then export most of the output . For semiconductors , countries like and Korea have recently fit this description . Moreover , this country could also import semiconductors from other countries which also have large factories , thus getting the benefits of competition and variety . A slightly more complex answer is that the country can get these benefits of economies of scale without producing semiconductors , but simply by buying semiconductors made at low cost around the world . An economy , especially a smaller country , may well end up specializing and producing a few items on a large scale , but then trading those items for other items produced on a large scale , and thus gaining the benefits of economies of scale by trade , as well as by direct production .

THE BENEFITS OF REDUCING BARRIERS TO INTERNATIONAL TRADE LEARNING By the end of this section , you will be able to Explain as barriers to trade Identify at least two benefits of reducing barriers to international trade are taxes that governments place on imported goods for a variety of reasons . Some of these reasons include protecting sensitive industries , for humanitarian reasons , and protecting against dumping . Traditionally , tariffs were used simply as a political tool to protect certain vested economic , social , and cultural interests . The World Trade Organization ( is committed to lowering barriers to trade . The worlds nations meet through the to negotiate how they can reduce barriers to trade , such as tariffs . negotiations happen in rounds , where all countries negotiate one agreement to encourage trade , take a year or two off , and then start negotiating a new agreement . The current round of negotiations is called the Round because it was officially launched in , the capital city of , in November 2001 . In 2009 , economists from the World Bank summarized recent research and found that the round of negotiations would increase the size of the world economy by 160 billion to 385 billion per year , depending on the precise deal that ended up being negotiated . In the context of a global economy that currently produces more than 30 trillion of goods and vices each year , this amount is not huge it is an increase of or less . But before dismissing the gains from trade too quickly , it is worth remembering two points . First , a gain of a few hundred billion dollars is enough money to deserve attention ! Moreover , remember that this increase is not a event it would persist each year into the future . Second , the estimate of gains may be on the low side because some of the gains from trade are not measured especially well in economic statistics . For example , it is difficult to measure the potential advantages to consumers of having a variety of products available and a greater degree of competition among producers . Perhaps the most important unmeasured factor is that trade between countries , especially when firms are splitting up the value chain of production , often involves a transfer of knowledge that can involve skills in production , technology , management , finance , and law .

PRINCIPLES or ECONOMICS 755 countries benefit more from trade than countries do . In some ways , the giant economy has less need for international trade , because it can already take advantage of internal trade within its economy . However , many smaller national economies around the world , in regions like Latin America , Africa , the Middle East , and Asia , have much more limited possibilities for trade inside their countries or their immediate regions . Without international trade , they may have little ability to benefit from comparative advantage , slicing up the value chain , or economies of scale . Moreover , smaller economies often have fewer competitive firms making goods within their , and thus firms have less pressure from other firms to provide the goods and prices that want . The economic gains from expanding international trade are measured in hundreds of billions of lars , and the gains from international trade as a whole probably reach well into the trillions of dollars . The potential for gains from trade may be especially high among the smaller and tries of the world . Visit this Website for a list of some benefits of trade . FROM INTERPERSONAL INTERNATIONAL TRADE Most people find it easy to believe that they , personally , would not be better off if they tried to grow and process all of their own food , to make all of their own clothes , to build their own cars and houses from scratch , and so on . Instead , we all benefit from living in economies where people and firms can specialize and trade with each other . The benefits of trade do not stop at national boundaries , either . Earlier we explained that the division of labor could increase output for three reasons ( workers with different characteristics can in the types of production where they have a comparative advantage ( firms and workers who specialize in a certain product become more productive with learning and practice and ( economies of scale . These three reasons apply from the individual and community level right up to the national level . If it makes sense to you that interpersonal , intercommunity , and interstate trade offer economic gains , it should make sense that international trade offers gains , too . International trade currently involves about 20 trillion worth of goods and services moving around the globe . Any economic force of that size , even if it confers overall benefits , is certain to cause tion and controversy . This chapter has only made the case that trade brings economic benefits . Other chapters discuss , in detail , the public policy arguments over whether to restrict international trade .

756 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER IT APPLE ( GLOBAL ) IPHONE Apple Corporation uses a global platform to produce the iPhone . Now that you understand the concept of comparative advantage , you can see why the engineering and design of the iPhone is done in the United States . The United States has built up a comparative advantage over the years in designing and marketing products , and sacrifices fewer resources to design devices relative to other countries . China has a comparative advantage in assembling the phone due to its large skilled labor force . Korea has a comparative advantage in producing components . Korea focuses its production by increasing its scale , learning better ways to produce screens and computer chips , and uses innovation to lower average costs of production . Apple , in turn , benefits because it can purchase these quality products at lower prices . Put the global assembly line together and you have the device with which we are all so familiar . KEY CONCEPTS AND SUMMARY Tariffs are placed on imported goods as a way of protecting sensitive industries , for humanitarian sons , and for protection against dumping . Traditionally , tariffs were used as a political tool to protect certain vested economic , social , and cultural interests . The has been , and continues to be , a way for nations to meet and negotiate through barriers to trade . The gains of international trade are very large , especially for smaller countries , but are beneficial to all . SELF ' QUESTIONS If the removal of trade barriers is so beneficial to international economic growth , Why would a nation continue to restrict trade on some imported or exported products ?

REVIEW QUESTIONS Are the gains from international trade more likely to be relatively more important to large or small countries ?

CRITICAL THINKING QUESTIONS . In World Trade Organization meetings , what do you think countries lobby for ?

Why might a country put up barriers to trade , such as tariffs on imports ?

Can a nation comparative advantage change over time ?

What factors would make it change ?

PROBLEMS If trade increases World by per year , what is the global impact of this increase over 10 years ?

How does this increase compare to the annual of a country like Sri ?

Discuss . Hint To answer this question , here are steps you may want to consider . Go to the World Development Indicators ( online ) published by the World Bank . Find the PRINCIPLES OF ECONOMICS 757 current level of World in constant international dollars . Also , find the of Sri in constant international dollars . Once you have these two numbers , compute the amount the additional increase in global incomes due to trade and compare that number to Sri . REFERENCES World Trade Organization . The Accessed October . The World Bank . Data World Development Accessed October . tariffs taxes that governments place on imported goods SOLUTIONS Answers to Questions A nation might restrict trade on imported products to protect an industry that is important for national security . For example , nation and nation may be geopolitical rivals , each with ambitions of increased political and economic strength . Even if nation has comparative advantage in the production of missile defense systems , it is unlikely that nation would seek to export those goods to nation . It is also the case that , for some nations , the production of a particular good is a key component of national identity . the production of rice is culturally very important . It may be difficult for japan to import rice from a nation like Vietnam , even if Vietnam has a comparative advantage in rice production .