na

1. Microeconomics
Module 14: Globalization and Trade

2. Why It Matters: Globalization and Trade
Globalization is the process by which the world,
previously isolated through physical and
technological distance, becomes increasingly
interconnected.
• What are the gains from international trade?
• In what sense do barriers to trade protect American
workers and companies?
• What are the costs of globalization? Are the costs
worth it?

3. Absolute Advantage
• The evidence that international trade confers overall benefits on economies is pretty
strong
• A country has an absolute advantage over another country if it can produce a given
product using fewer resources than the other country needs to use
• If Canada can produce 100 lbs. of beef using two ranchers, but it takes Argentina three
ranchers, Canada has absolute advantage over Argentina
• Absolute advantage can be the result of a country’s natural endowment
• Saudi Arabia and oil

4. Comparative Advantage
• Comparative Advantage: when a country can produce a good at a lower cost in
terms of other goods; or, when a country has a lower opportunity cost of production
• The question each country or company should ask with trade should be: “What do we give up
to produce this good?”
• If Zambia produces copper, the resources it uses cannot be used to produce other goods such
as corn
• As a result, Zambia gives up the opportunity to produce corn
• Suppose it takes 10 hours of labor to mine a ton of copper in Zambia, and 20 hours of labor to
harvest a bushel of corn
• This means the opportunity cost of producing a ton of copper is 2 bushels of corn

5. Absolute or Comparative Advantage
If Ryen can make more tacos in an hour than Suzanne, but Suzanne can make more
tacos at a lower opportunity cost, then Suzanne has a(n) ________.
a. comparative advantage in making tacos
b. both an absolute and comparative advantage in making tacos.
c. absolute advantage in making tacos

6. What Happens When a Country Has an Absolute
Advantage in All Goods
• It’s typical that for high-income countries they have well-educated workers,
technologically advanced equipment, etc.
• These high-income countries can produce all products with fewer resources than a
low-income country
• If the high-income country is more productive across the board, will there still be
gains from trade?
• Trade is about a 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 one’s comparative
advantage

7. Production Possibilities and Comparative Advantage
Table 1. Resources Needed to Produce Shoes and Refrigerators
Country
Number of Workers needed
to produce 1,000 units —
Shoes
Number of Workers needed
to produce 1,000 units —
Refrigerators
United States 4 workers 1 worker
Mexico 5 workers 4 workers
• Absolute advantage simply compares the productivity of a worker between countries
• Comparative advantage identifies the good for which the producer’s absolute
advantage is relatively larger, or where the producer’s absolute productivity
disadvantage is relatively smaller

8. 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
• The production possibilities frontier is a useful tool to visualize this benefit
• The production possibilities frontier shows the maximum amount that each country can
produce given its limited resources

9. Calculating Absolute and Comparative Advantage
• Step 1: Make a Table, similar to the one shown
• Step 2: To calculate absolute advantage, look at
the larger of the numbers for each product
• Step 3: To calculate comparative advantage, find
the opportunity cost of producing one barrel of oil
in both countries
• Step 4: Calculate the opportunity cost of one
lumber by reversing the numbers, with lumber on
the left side of the equation
• Step 5: In this example, absolute advantage is
the same as comparative advantage
• Step 6: Canada should specialize in what it has a
relative lower opportunity cost, which is lumber,
and Venezuela should specialize in oil
Table 6. Oil and Lumber Production in Canada and
Venezuela
Country
Oil
(barrels)
Lumber
(tons)
Canada 20 or 40
Venezuela 60 or 30

10. Trade and Incomes
• Incomes depend on labor productivity
• A country with an absolute advantage in some product has higher labor productivity
• The average income in a country depends on its average labor productivity
• Comparative advantage is more important than absolute advantage in understanding
which country should trade which product in order to maximize the standard of living
in both countries

11. The Prevalence of Intra-Industry Trade between Similar
Economies
• 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 is intra-industry trade, trade of goods within the same
industry from one country to another
• The benefits of having workers with similar skills work in other parts of the world are:
• The division of labor leads to learning, innovation, and unique skills
• Economies of scale

12. Gains from Specialization and Learning
• 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 produced in stages
• Instead of production in a single large factory, all of the steps of production can be
split up among different firms operating in different places and even different
countries
• Because firms split up the value chain, international trade often does not involve
whole finished products
• Intra-industry trade between similar countries produces economic gains because it
allows workers and firms to learn and innovate on particular products

13. Economies of Scale, Competition, Variety
• A second broad reason that intra-
industry trade between similar nations
produces economic gains involves
economies of scale
• The concept of economies of
scale means that as the scale of
output goes up, average costs of
production decline
• The horizontal axis of the figure
shows the quantity of production by a
certain firm or at a certain
manufacturing plant

14. Economies of Scale Advantages
• 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
• 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 U.S. automobile market was made up of only General Motors, Ford, and Chrysler, the
level of competition and consumer choice would be quite a lot lower
• Greater competition brings with it innovation and responsiveness to what consumers
want

15. Dynamic Comparative Advantage
• The sources of gains from intra-industry trade between similar economies
• In intra-industry 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 productivity is determined by how firms engage in
specific learning about specialized products
• In this vision, comparative advantage can be dynamic, it can evolve and change
over time as new skills are developed and as the value chain is split up in new ways

16. Demand and Supply Analysis of International Trade
• We can use the theory of supply and demand to further understand the benefits of
international trade
• Consider two countries, Brazil and the United States, who produce sugar
• If international trade between Brazil and the U.S. becomes possible, firms will want to buy
cheap in Brazil and sell at a high price in the U.S.

17. Protectionism
• Globalization has brought fear of loss of jobs and loss of income, which are often
described as the “race to the bottom”
• Globalization has also spawned fears about loss of culture
• Many countries worry about their cultures being overwhelmed by that of the United
States
• When a government legislates policies to reduce or block international trade it is
engaging in protectionism
• Protectionist policies often seek to shield domestic producers and domestic workers
from foreign competition
• The Trump Administration’s tariffs on steel and aluminum in 2018 are a recent
example

18. Barriers to Trade
• Protectionism takes three main forms:
• Tariffs are taxes that a government imposes on imported goods and services
• Makes imports more expensive, discourages purchases
• Import quotas are numerical limitations on the quantity of products that a country can import
• During the early 1980s, the Reagan Administration imposed a quota on the import of Japanese automobiles
• Nontariff barriers are all the other ways that a nation can draw up rules, regulations,
inspections, and paperwork to make it more costly or difficult to import products
• Textiles made in the U.S. are shipped to another country, combined with textiles from another country and then
shipped back to the U.S. for final assembly

19. The Tradeoffs of International Trade
• The common belief among economists is that it is better to embrace the gains from
trade, and then deal with the costs and tradeoffs with other policy tools, instead of no
trade at all
• Most people who live in market-oriented economies would oppose trying to block
better products that lower the cost of services
• The economic analysis of free trade does not rely on a belief that foreign trade is not
disruptive or does not pose tradeoffs
• Disruptive market change happens when a innovative new product or production
technology disrupts the status quo in a market
• The potential for gains from trade may be especially high among the smaller and
lower-income countries of the world

20. From Interpersonal to International Trade
• 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
• The division of labor could increase output for three reasons:
1. Workers with different characteristics can specialize in the types of production where they
have a comparative advantage
2. Firms and workers who specialize in a certain product become more productive with learning
and practice
3. Economies of scale
• These three reasons apply from the individual and community level right up to the
international level

21. Reducing Barriers to Trade
• At the end of World War II, there was a consensus that tariffs were too high worldwide
• Tariff reductions could stimulate international trade and return the world to a thriving,
peacetime economy
• The General Agreement on Tariffs and Trade (GATT), was established in 1947 by the
U.N. to provide a forum in which nations could come together to negotiate reductions in
tariffs and other barriers to trade
• In 1995, the GATT was transformed into the World Trade Organization (WTO)
• The GATT process was to negotiate an agreement to reduce barriers to trade, sign that
agreement, pause for a while, and then start negotiating the next agreement

22. The Negotiating Rounds of GATT and the World Trade
Organization
Year Place or Name of Round Main Subjects
Number of Countries
Involved
1947 Geneva Tariff reduction 23
1949 Annecy Tariff reduction 13
1951 Torquay Tariff reduction 38
1956 Geneva Tariff reduction 26
1960–61 Dillon round Tariff reduction 26
1964–67 Kennedy round Tariffs, anti-dumping measures 62
1973–79 Tokyo round Tariffs, nontariff barriers 102
1986–94 Uruguay round
Tariffs, nontariff barriers, services,
intellectual property, dispute settlement,
textiles, agriculture, creation of WTO
123
2001– Doha round
Agriculture, services, intellectual property,
competition, investment, environment,
dispute settlement
147
Table 1. The Negotiating Rounds of GATT and the World Trade Organization

23. The World Trade Organization
• The WTO is committed to lowering barriers to trade
• The world’s nations meet through the WTO to negotiate how they can reduce
barriers to trade, such as tariffs
• WTO 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
• Like the GATT before it, the WTO is not a world government, with power to impose
its decisions on others
• The total staff of the WTO in 2013 is 629 people and its annual budget (as of 2012)
is $196 million
• Compared to large universities, the budget is smaller in size

24. Regional Trading Agreements
• Three types of economic integration across the globe:
• Free trade agreements are when participants allow each other’s imports without tariffs or
quotas
• Common markets is when participants have a common external trade policy
• Economic unions, in addition to a common market, monetary and fiscal policies are
coordinated
• The best known of these regional trading agreements is the European Union
• For the United States, perhaps the best-known regional trading agreement is
the North American Free Trade Agreement (NAFTA)

25. Long-Term in Barriers to Trade
• Through all the controversy with trade policy, the general trend for most of the last
60 years is clearly toward lower barriers to trade
• Although measures of import quotas and nontariff barriers are less exact than those
for tariffs, they generally appear to be at lower levels, too
• The last half-century has seen both a dramatic reduction in government-created
barriers to trade, like tariffs, import quotas, and nontariff barriers
• A number of technological developments that have made international trade easier
• advances in transportation, communication, and information management
• The result has been the powerful surge of international trade

26. Quick Review
• What is absolute advantage and comparative advantage?
• How do you calculate absolute and comparative advantage?
• What are two advantages of intra-industry trading?
• What is the relationship between economies of scale and intra-industry trade?
• How can you use supply and demand to explain the gains from trade?
• Why do governments justify protectionist policies?
• What are trade barriers, including quotas, tariffs, and nontariff barriers?

27. More Quick Review
• What are the tradeoffs of trade policy, and what are two benefits from reducing trade
barriers?
• What is the origin and role of the General Agreement on Tariffs and Trade (GATT)?
• What is the origin and role of the World Trade Organization (WTO)?
• What is the significance and examples of regional trading agreements?
• Analyze trade policy and evaluate long-term trends in barriers to trade