Micro ch9 ppt

R. GLENN
HUBBARD
Microeconomics
FOURTH EDITION
ANTHONY PATRICK
O’BRIEN

2 of 43© 2013 Pearson Education, Inc. Publishing as Prentice Hall
Comparative Advantage and the
Gains from International Trade
CHAPTER
9
Chapter Outline and
Learning Objectives
9.1 The United States in the
International Economy
9.2 Comparative Advantage in
International Trade
9.3 How Countries Gain from
International Trade
9.4 Government Policies That
Restrict International Trade
9.5 The Arguments over Trade
Policies and Globalization

Does the Federal Government’s “Buy American” Policy
Help U.S. Firms?
• In response to the economic recession of 2007–2009, Congress and
President Obama passed the American Recovery and Reinvestment Act of
2009, which included tax cuts and increased government spending.
• The bill included a “Buy American” provision that required all manufactured
goods bought with these funds to be made in the United States.
• The intention was to increase the number of jobs the bill would create by
preventing foreign companies from participating in the new spending projects.
• Some U.S. firms were opposed to the Buy American provision.
• AN INSIDE LOOK AT POLICY on page 298 examines a federal lawsuit
against Home Depot, alleging that the company violated the Buy American
provision.

Have You Heard of the “Buy American” Provision?
Politicians often support restrictions on trade to convince people to vote for
them. The workers in the industries these restrictions protect are likely to vote
for them because they think trade restrictions will protect their jobs.
But most people are not workers in industries protected from foreign
competition by trade restrictions. Many people work for firms that sell goods in
foreign markets and risk losing their jobs if foreign countries retaliate against
U.S. attempts to reduce imported goods.
See if you can answer these questions by the end of the chapter:
How did some U.S. companies convince Congress to include the Buy American
provision in the American Recovery and Reinvestment Act of 2009, and why
have relatively few people even heard of this provision?
Economics in Your Life

Discuss the role of international trade in the U.S. economy.
9.1 LEARNING OBJECTIVE
The United States in the International Economy

Tariff A tax imposed by a government on imports.
Imports Goods and services bought domestically but produced in other countries.
Exports Goods and services produced domestically but sold in other countries.

The Importance of Trade to the U.S. Economy
Figure 9.1 International Trade Is of Increasing Importance to the United States
Exports and imports of goods and services as a percentage of total production—measured
by GDP—show the importance of international trade to an economy.
Since 1970, both imports and exports have been steadily rising as a fraction of U.S. GDP.

U.S. International Trade in a World Context
Figure 9.2 The Eight Leading Exporting Countries, 2010
The United States is the leading exporting country, accounting for 9.7 percent of total
world exports.
The values are the shares of total world exports of merchandise and commercial services.

Figure 9.3 International Trade as a Percentage of GDP
International trade is still less important to the United States than to most other countries.

Caterpillar has become increasingly dependent on foreign markets, with its firm’s exports
rising from just over half of total sales in 2004 to more than two-thirds in 2010.
How Caterpillar Depends on International Trade
Making
the
Connection
Your Turn: Test your understanding by doing related problem 1.7 at the end of this chapter.MyEconLab

Understand the difference between comparative advantage and absolute
advantage in international trade.
Comparative Advantage in International Trade

A Brief Review of Comparative Advantage
Comparative advantage The ability of an individual, a firm, or a country to
produce a good or service at a lower opportunity cost than competitors.
Opportunity cost The highest-valued alternative that must be given up to
engage in an activity.
Comparative Advantage in International Trade
Table 9.1 An Example of Japanese Workers Being More Productive Than American Workers
Output per Hour of Work
Cell Phones Tablet Computers
Japan 12 6
United States 2 4

Absolute advantage The ability to produce more of a good or service than
competitors when using the same amount of resources.
Table 9.2 The Opportunity Costs of Producing Cell Phones and Tablet Computers
The table shows the opportunity cost each country faces in producing cell phones and
tablet computers.
For example, the entry in the first row and second column shows that Japan must give
up 2 cell phones for every tablet computer it produces.
Opportunity Costs
Japan 0.5 tablet computer 2 cell phones
United States 2 tablet computers 0.5 cell phone

Explain how countries gain from international trade.
How Countries Gain from International Trade

Autarky A situation in which a country does not trade with other countries.
Table 9.3 Production without Trade
Production and Consumption
Japan 9,000 1,500
United States 1,500 1,000
Increasing Consumption through Trade
Terms of trade The ratio at which a country can trade its exports for imports
from other countries.
Countries gain from specializing in producing goods in which they have a
comparative advantage and trading for goods in which other countries have a
comparative advantage.

Table 9.4 Gains from Trade for Japan and the United States

Solved Problem 9.3
The Gains from Trade
David Ricardo provided a famous example of the gains from trade, using wine and cloth
production in Portugal and England. The following table is adapted from Ricardo’s
example, with cloth measured in sheets and wine measured in kegs:
Output per Year of Labor
Cloth Wine
Portugal 100 150
England 90 60
a. Explain which country has an absolute advantage in the production of each good.
b. Explain which country has a comparative advantage in the production of each good.
c. Suppose that Portugal and England currently do not trade with each other.
Each country has 1,000 workers, so each has 1,000 years of labor time to use
producing cloth and wine, and the countries are currently producing the amounts of
each good shown in the following table:
Cloth Wine
Portugal 18,000 123,000
England 63,000 18,000
Show that Portugal and England can both gain from trade. Assume that the terms of
trade are that one sheet of cloth can be traded for one keg of wine.

Solved Problem 9.3
Solving the Problem
Step 1: Review the chapter material.
Step 2: Answer part a. by determining which country has an absolute advantage.
The first table in the problem shows that Portugal can produce more cloth and more wine
with one year’s worth of labor than can England.
Thus, Portugal has an absolute advantage in the production of both goods and England
has an absolute advantage in the production of neither.
Step 3: Answer part b. by determining which country has a comparative advantage.
To produce 100 sheets of cloth, Portugal must give up producing 150 kegs of wine.
Therefore, the opportunity cost to Portugal of producing 1 sheet of cloth is 150/100, or 1.5
kegs of wine. England has to give up producing 60 kegs of wine to produce 90 sheets of
cloth, so its opportunity cost of producing 1 sheet of cloth is 60/90, or 0.67 keg of wine.
Opportunity Costs
Cloth Wine
Portugal 1.5 kegs of wine 0.67 sheet of cloth
England 0.67 keg of wine 1.5 sheets of cloth
Portugal has a comparative advantage in wine because its opportunity cost is lower.
England has a comparative advantage in cloth because its opportunity cost is lower.

Solved Problem 9.3
Step 4: Answer part c. by showing that both countries can benefit from trade.
Without Trade
Production and Consumption
Cloth Wine
Portugal
England
18,000
63,000
123,000
18,000
With Trade
Production
with Trade Trade
Consumption
with Trade
Cloth Wine Cloth Wine Cloth Wine
Portugal 0 150,000 Import 18,000 Export 18,000 18,000 132,000
England 90,000 0 Export 18,000 Import 18,000 72,000 18,000
Gains from Trade
Increased Consumption
Portugal
England
9,000 wine
9,000 cloth
Your Turn: For more practice, do related problems 3.5 and 3.6 at the end of this chapter.MyEconLab

Why Don’t We See Complete Specialization?
We do not see complete specialization in the real world for three main reasons:
• Not all goods and services are traded internationally. Some services are
difficult to export, such as medical care.
• Production of most goods involves increasing opportunity costs. If a
country devotes more workers to producing a good, the opportunity cost of
producing more of that good will increase, causing the country to stop short
of complete specialization.
• Tastes for products differ. Most products are differentiated. As a result,
countries may each have a comparative advantage in producing different
varieties of a particular product.
Don’t Let This Happen to You
Remember That Trade Creates Both Winners and Losers
Trade is a win–win situation for all countries that participate, but some individuals always lose.
Countries do not produce goods—firms do, and some lose. The losers are likely
to try to convince their governments to interfere by barring imports of the
competing products from the other country or by imposing high tariffs on them.
Does Anyone Lose as a Result of International Trade?

Where Does Comparative Advantage Come From?
Among the main sources of comparative advantage are the following:
• Climate and natural resources. Geology can create comparative advantage.
• Relative abundance of labor and capital. Some countries have a comparative
advantage in producing goods requiring highly skilled workers and sophisticated
machinery, while others have a comparative advantage requiring unskilled
workers and relatively simple machinery.
• Technology. Broadly defined, technology is the process firms use to turn inputs
into goods and services.
Some countries are strong in product technologies, which involve the ability to
develop new products.
Other countries are strong in process technologies, which involve the ability to
improve the processes used to make existing products.
• External economies. Once an industry becomes established in an area, firms
that locate in that area gain advantages over firms located elsewhere.
External economies Reductions in a firm’s costs that result from an increase
in the size of an industry.

The original concentration of financial
firms in Manhattan was something of a
historical accident, thanks to the
Erie Canal.
New York has since continued to see a
high concentration of financial firms, with
some firms that temporarily left deciding
to return because of the benefits they
receive from the external economies of
being located in New York City.
Large financial firms located outside Manhattan, particularly those that heavily
trade securities or attempt to make deals that involve mergers between firms,
may have higher costs than firms located in Manhattan.
Having many financial firms originally located in Manhattan was a historical
accident, but external economies gave the area a comparative advantage in
providing financial services once the industry began to grow there.
Leave New York City? Risky for Financial Firms
Making
the
Connection

Comparative Advantage over Time: The Rise and Fall—and Rise—
of the U.S. Consumer Electronics Industry
A country may develop a comparative advantage in the production of a good,
and then, as time passes and circumstances change, the country may lose its
comparative advantage in producing that good and develop a comparative
advantage in producing other goods.
For several decades, the United States had a comparative advantage in the
production of consumer electronic goods, such as televisions, radios, and
stereos. The comparative advantage of the United States in these products was
based on having developed most of the underlying technology, having the most
modern factories, and having a skilled and experienced workforce.
Gradually, however, other countries, particularly Japan, gained access to the
technology, built modern factories, and developed skilled workforces.
By 2011, however, as the technology underlying consumer electronics had
evolved, comparative advantage had shifted again, and several U.S. firms had
surged ahead of their Japanese competitors.
Once a country has lost its comparative advantage in producing a good, its
income will be higher and its economy will be more efficient if it switches from
producing the good to importing it, as the United States did when it switched
from producing televisions to importing them.

Analyze the economic effects of government policies that restrict international trade.
Government Policies That Restrict International Trade

Free trade Trade between countries that is without government restrictions.
Figure 9.4
The U.S. Market for Ethanol
under Autarky
This figure shows the market
for ethanol in the United
States, assuming autarky,
where the United States
does not trade with other
countries.
The equilibrium price of
ethanol is $2.00 per gallon,
and the equilibrium quantity
is 6.0 billion gallons per year.
The blue area represents
consumer surplus,
and the red area represents
producer surplus.

Figure 9.5
The Effect of Imports on the
U.S. Ethanol Market
When imports are allowed into the
United States, the price of ethanol
falls from $2.00 to $1.00.
U.S. consumers increase their
purchases from 6.0 billion
to 9.0 billion gallons.
Equilibrium moves from point F
to point G.
U.S. producers reduce the quantity
of ethanol they supply from 6.0
billion to 3.0 billion gallons.
Imports equal 6.0 billion gallons,
which is the difference between
U.S. consumption and U.S.
production.
Consumer surplus equals the
areas A, B, C, and D.
Producer surplus equals the
area E.
Government policies that restrict trade usually take one of two forms: tariffs or
quotas and voluntary export restraints.

Figure 9.6
The Effects of a Tariff on Ethanol
Without a tariff on ethanol, U.S.
producers will sell 3.0 billion
gallons of ethanol,
U.S. consumers will purchase 9.0
billion gallons,
and imports will be 6.0 billion gallons.
The U.S. price will equal the world
price of $1.00 per gallon.
The $0.50-per-gallon tariff raises the
price of ethanol in the United States
to $1.50 per gallon, and
U.S. producers increase the quantity
they supply to 4.5 billion gallons.
U.S. consumers reduce their
purchases to 7.5 billion gallons.
Tariffs
Equilibrium moves from point G to point H.
The ethanol tariff causes a loss of consumer surplus equal to the area A + C + T + D.
The area A is the increase in producer surplus due to the higher price.
The area T is the government’s tariff revenue.
The areas C and D represent deadweight loss.

Quotas and Voluntary Export Restraints
Quota A numerical limit a government imposes on the quantity of a good that
can be imported into the country.
Voluntary export restraint (VER) An agreement negotiated between two
countries that places a numerical limit on the quantity of a good that can be
imported by one country from the other country.
Measuring the Economic Effect of the Sugar Quota
We can use the concepts of consumer surplus, producer surplus, and
deadweight loss to measure the economic impact of the sugar quota.

Figure 9.7
The Economic Effect of the U.S. Sugar Quota
Without a sugar quota, U.S. sugar
producers would have sold 4.7 billion
pounds of sugar,
U.S. consumers would have purchased
27.5 billion pounds of sugar, and
imports would have been 22.8 billion pounds.
The U.S. price would have equaled the
world price of $0.28 per pound.
Because the sugar quota limits imports to
5.3 billion pounds (the bracket in the graph),
the price of sugar in the United
States rises to $0.53 per pound, and
U.S. producers supply 15.9 billion pounds.
U.S. consumers purchase 21.2 billion
pounds rather than the 27.5 billion pounds
they would purchase at the world price.
Without the import quota, equilibrium would be at point E;
with the quota, equilibrium is at point F.
The sugar quota causes a loss of consumer surplus equal to the area A + B + C + D.
The area A is the gain to U.S. sugar producers.
The area B is the gain to foreign sugar producers.
The areas C and D represent deadweight loss.
The total loss to U.S. consumers in 2010 was $6.08 billion.

Without Quota With Quota
World price of apples
U.S. price of apples
Quantity supplied by U.S. firms
Quantity demanded by U.S. consumers
Quantity imported
Area of consumer surplus
Area of domestic producer surplus
Area of deadweight loss
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
Solved Problem 9.4
Measuring the Economic Effect
of a Quota
The U.S. government decides to restrict
international trade in apples by imposing a
quota that allows imports of only 4 million boxes
of apples into the United States each year.
Fill in the following table, using the prices,
quantities, and letters in the figure:
Solving the Problem
Step 1: Review the chapter material.
Step 2: Fill in the table.
Your Turn: For more practice, do related problem 4.14 at the end of this chapter.MyEconLab
$10
$10
6 million boxes
16 million boxes
10 million boxes
A + B + C + D + E + F
G
No deadweight loss
$10
$12
10 million boxes
14 million boxes
4 million boxes
A + B
G + C
D + F

The High Cost of Preserving Jobs with Tariffs and Quotas
Product
Number of Jobs
Saved
Cost to Consumers per Year
for Each Job Saved
Benzenoid chemicals
Luggage
Softwood lumber
Dairy products
Frozen orange juice
Ball bearings
Machine tools
Women's handbags
Canned tuna
216
226
605
2,378
609
146
1,556
773
390
$1,376,435
1,285,078
1,044,271
685,323
635,103
603,368
479,452
263,535
257,640
Table 9.5 Preserving U.S. Jobs with Tariffs and Quotas Is Expensive

Table 9.6 Preserving Japanese Jobs with Tariffs and Quotas Is Also Expensive
Product
Cost to Consumers per
Year for Each Job Saved
Rice
Natural gas
Gasoline
Paper
Beef, pork, and poultry
Cosmetics
Radio and television sets
$51,233,000
27,987,000
6,329,000
3,813,000
1,933,000
1,778,000
915,000

Save Jobs Making Hangers . . .
and Lose Jobs in Dry Cleaning
Making
the
Connection
A tariff on hangers increased the cost of
doing business for U.S. dry cleaners.
Under trade agreements signed with
other countries, the United States is
allowed to impose tariffs on imports if
foreign firms are selling products in the
United States at below their
production cost.
The U.S. International Trade Commission
(ITC) determined that Chinese firms had,
in fact, been selling wire garment hangers
in the United States at below the firms’
production cost and so imposed a tariff
on imports of the hangers.
The tariff sharply increased dry cleaners’ costs as many struggled to pay their
workers, let alone stay in business.
As dry cleaners, their employees, and consumers buying wire hangers found out,
tariffs can be both an expensive and ineffective way to attempt to preserve jobs.

Gains from Unilateral Elimination of Tariffs and Quotas
Some politicians argue that eliminating U.S. tariffs and quotas would help the
U.S. economy only if other countries eliminated their tariffs and quotas in
exchange.
It is easier to gain political support for reducing or eliminating tariffs or quotas if
it is done as part of an agreement with other countries that involves their
eliminating some of their tariffs or quotas.
But as the example of the sugar quota shows, the U.S. economy would gain
from the elimination of tariffs and quotas even if other countries did not reduce
their tariffs and quotas.
Other Barriers to Trade
In addition to tariffs and quotas, governments sometimes erect other barriers
to trade, such as stricter health and safety requirements on imported goods.
Many governments also restrict imports of certain products on national
security grounds.

Evaluate the arguments over trade policies and globalization.
The Arguments over Trade Policies and Globalization

To reduce tariffs and revive international trade after World War II, government
officials in the United States and Europe set up the General Agreement on
Tariffs and Trade (GATT) in 1948.
A series of multilateral negotiations, called trade rounds, took place, in which
countries agreed to reduce tariffs from the very high levels of the 1930s.
In the following decades, trade in services and in products incorporating
intellectual property, such as software programs and movies, grew in
importance and in January 1995, GATT was replaced by the World Trade
Organization (WTO).
World Trade Organization (WTO) An international organization that oversees
international trade agreements.

Why Do Some People Oppose the World Trade Organization?
Globalization The process of countries becoming more open to foreign trade
and investment.
The opposition to the WTO comes from three sources:
1. Some opponents are specifically against the globalization process that
began in the 1980s and became widespread in the 1990s.
2. Other opponents have the same motivation as the supporters of tariffs in the
1930s—to erect trade barriers to protect domestic firms from foreign
competition.
3. Some critics of the WTO support globalization in principle but believe that the
WTO favors the interests of the high-income countries at the expense of the
low-income countries.

Anti-Globalization Many of those who protest at WTO meetings distrust
globalization.
Some believe that by increasing the variety of products available to
consumers in developing countries, free trade and foreign investment destroy
the distinctive cultures of those countries.
Globalization has also allowed multinational corporations to relocate factories
from high-income countries to low-income countries.
Some people have argued that firms with factories in developing countries
should pay workers wages as high as those paid in high-income countries,
abiding by the same health, safety, and environmental regulations.
The governments of most developing countries have arguments against
these proposals.

Would eliminating child labor, such as
stitching soccer balls, improve the
quality of children’s lives?
The Unintended Consequences of Banning Goods
Made with Child Labor
Making
the
Connection
In the United States, boycotts have been
organized against stores that stock
goods made in developing countries with
child labor.
Many people assume that if child
workers in developing countries weren’t
working in factories, they would be in
school, as are children in high-income
countries.
In fact, there is substantial evidence that
as incomes begin to rise in poor countries,
families rely less on child labor, which the
United States didn’t outlaw until 1938.
Meanwhile, children in developing countries usually have few good alternatives
to work: When France banned soccer balls made by child workers for the 1998
World Cup, many Pakistani children went from hand-stitching in a structured
environment to begging or prostitution.

Protectionism The use of trade barriers to shield domestic firms from foreign
competition.
“Old-Fashioned” Protectionism
• Saving jobs. Supporters of protectionism argue that free trade reduces
employment by driving domestic firms out of business.
• Protecting high wages. Some people worry that firms in high-income
countries will have to start paying much lower wages to compete with firms
in developing countries.
• Protecting infant industries. Others argue that under free trade,
established foreign producers can sell their products at a lower price and
drive domestic producers out of business before they gain enough
experience to compete.
• Protecting national security. It is rare for an industry to ask for
protection without raising the issue of national security, even if its products
have mainly nonmilitary uses.
Protectionism is usually justified on the basis of one of the following arguments:

Dumping
Dumping Selling a product for a price below its cost of production.
Positive analysis concerns what is.
Normative analysis concerns what ought to be.
The success of industries in getting the government to erect barriers to foreign
competition depends partly on some members of the public knowing the costs
of trade barriers but supporting them anyway.
However, two other factors are also at work:
Positive versus Normative Analysis (Once Again)
1. The costs tariffs and quotas impose on consumers are large in total but
relatively small per person.
2. The jobs lost to foreign competition are easier to identify than are the jobs
created by foreign trade.

Have You Heard of the “Buy American” Provision?
At the beginning of the chapter, we asked you to consider how some U.S.
companies convinced Congress to include the Buy American provision in the
American Recovery and Reinvestment Act and why relatively few people have
heard of this provision.
In the chapter, we saw that trade restrictions tend to preserve relatively few jobs
in the protected industries, while leading to job losses in other industries and
costing consumers billions per year in higher prices.
This might seem to increase the mystery of why Congress enacted the Buy
American provision, yet we have also seen that per person, the burden of
specific trade restrictions can be small.
In fact, few people will even spend the time to become aware that a specific
trade restriction exists.
Economics in Your Life

AN
INSIDE
LOOK
AT POLICY
Did Home Depot Knowingly Defy the “Buy American”
Policy?
The effect of the “Buy American” provision
on the steel market in the United States.
Company Settlement Date
Fastenal $6.25 million 2011
Corporate Express
Office Products
5.02 million 2006
Staples 7.4 million 2005
Office Depot 4.75 million 2005
Office Max 9.72 million 2005
Invacare 2.6 million 1998
The table above lists several major
companies that made settlement payments
to the U.S. government following litigation
for allegedly violating the Buy American
provision or the Trade Agreements Act.
The Home Depot case is not the first filed against a major U.S. corporation for violating the
Buy American provision.

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