McConnell 22nd edition

1. CHAPTER 40
International Trade

2. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education.
The Economic Basis for Trade
Supply and Demand Analysis of Exports and Imports
Trade Barriers and Export Subsidies
The Case for Protection: A Critical Review
Multilateral Trade Agreements and Free-Trade Zones
Chapter Contents
40-2

3. Global Economy
• Households and firms in the U.S. economy interact with
households and firms in other economies in two main ways:
• International Trade: They buy and sell goods and services.
• International Finance: They borrow and lend.

4. Global Economy
• Households and firms in the U.S.
economy interact with those in
the rest of the world in goods
markets and financial markets.
• The red flow shows the
expenditure by Americans on
imports of goods and services.
• The blue flow shows the
expenditure by the rest of the
world on U.S. exports (other
countries’ imports).

5. Global Economy
• The green flow shows U.S.
lending to the rest of the world.
• The orange flow shows U.S.
borrowing from the rest of the
world
• These international trade and
international finance flows tie
nations together.
• Global booms and slumps are
transmitted through these flows.

6. U.S. Trade Facts
• U.S. exports and imports
as shares of gross
domestic product have
been on a long-term
upward trend.
• International trade has
roughly tripled in
importance compared to
the economy as a whole
in the past 50 years.
Exports and Imports as a Percentage of U.S. GDP

7. Global Perspective 40.1
Source: Organisation for Economic Cooperation and Development (OECD).
LO40.1
SHARES OF WORLD EXPORTS, TOP EIGHT EXPORTING COUNTRIES
40-7
• Compared to the United States,
other countries are even more
tied to international trade.
• Their imports and exports as a
share of GDP are substantially
higher.
• The United States, due to its
size and diversity of resources,
relies less on international
trade than almost any other
country.

8. Global Perspective
• In 2013, the world as a whole
produced goods and services
worth about $74 trillion at current
price.
• World trade in goods and services
exceeded $23 trillion in 2013.
• More than 30% of world output is
sold across national borders.
• The U.S. is the second largest
exporter in the world.

9. U.S. Trade Facts
• The 5 largest trading partners
with the U.S. in 2012 were
Canada, China, Mexico, Japan,
and Germany.
• Two of top five trading partners
are our neighbors: Canada and
Mexico.
• Three of top five trading
partners are those top five
largest economies in the world:
China (2nd largest economy),
Japan (3rd), Germany (4th).
Total U.S. Trade with Major Partners, 2012

10. U.S. Trade Facts
• Trade surplus when exports exceed imports
• Trade deficits when imports exceeds exports
• U.S. trade deficit in goods: $891 billion in 2018
• U.S. trade surplus in services: $270 billion in 2018
• Trade deficit with China: $419 billion in 2018
• The U.S. has had trade deficits every year since 1977.
LO40.1
40-10

11. • Principal U.S. exports
• Chemicals
• Agricultural products
• Consumer durables
• Computer software and
services
• Aircraft
• Principal U.S. imports
• Petroleum
• Automobiles
• Metals
• Household appliances
• Computers
U.S. Trade Facts

12. Specialization and Exchange
• Specialization: People concentrate on what they are good at.
• Specialization leads to greater production of goods and services
without increasing inputs.
• Mutual Gains from Voluntary Exchange: A voluntary exchange
between two parties must make both parties better off.
Before
Exchange
After
Exchange
Exchange

13. Specialization and Trade
• Nations have different resource endowments
• Land, Labor, Capital, and Entrepreneur
• Goods and services are produced with different combinations of
resources
• Land-intensive goods: Agricultural & mining goods
• Labor-intensive goods: Manufacturing & services
• Capital-intensive goods: Manufacturing & services
• Some economies are good at producing land-intensive goods (U.S.,
Australia), while others are good at Labor-intensive (China, Vietnam)
or Capital-intensive goods (U.S., Japan).
LO40.2
40-13

14. Gains from pecialization and Trade
• If each country specialize to produce goods and services that
they are good at, then the world can produce more goods and
services than each country try to produce all kind of goods and
services.
• Any excess production of goods and services can be exchanged
among countries – international trade. Since such trade is
voluntary, trade must be beneficial to all countries.
• After trade, each country can consumer more than it could do
by itself.

15. Assumptions and Opportunity Cost Ratio
• Assumptions:
• Two nations
• Same size labor force
• Constant costs in each country
• Different costs between countries
• United States has absolute advantage in both
• Opportunity cost ratio:
• Slope of the curve
• Vegetables sacrificed per ton of beef
LO40.2
40-15

16. International Trade Model
• Assumptions & Setup
• Two nations: U.S. and Mexico
• Two goods: Vegetables and Beef
• Labor is only resource for production of goods
• Same size labor force in two countries
• Constant costs to produce each good in each country
• Different costs between countries
LO40.2
40-16

17. Production Possibilities for the United States and
Mexico
Vegetables(tons)
30
25
20
15
10
5
0 5 10 15 20 25 30
Beef (tons)
(a)
United States
A
Z
B
V
30
25
20
15
10
0 5 10 15 20
v
b
Beef (tons)
(b)
Mexico
Vegetables(tons)
12
18 8
4
LO40.2
40-17
• U.S. can produce
maximum of 30
tons of vegetables
or 30 tons of beef.
• U.S. currently
produces 12 tons
of vegetable or 18
tons of beef
• Mexico can produce
maximum of 20
tons of vegetables
or 10 tons of beef.
• Mexico currently
produces 4 tons of
vegetable or 8 tons
of beef

18. Absolute Advantage
• Absolute advantage: one country is more productive than another
country—needs fewer inputs or takes less time to produce a good
or perform a production task.
• U.S. has an absolute advantage in production of both vegetables
and beef over Mexico.
• With same number of labor the U.S. can produce more vegetables
than Mexico (30 tons > 20 tons) when both countries allocate all labor
resource in vegetable production.
• With same number of labor the U.S. can produce more beef than
Mexico (30 tons > 10 tons) when both countries allocate all labor
resource in beef production.

19. Comparative Advantage
• Comparative advantage: the ability of a country to produce a good
or service at a lower opportunity cost than another country.
• When one country has a comparative advantage in producing one
good, the other country has a comparative advantage in producing
the other goods.
• Opportunity cost: Opportunity cost of producing one good is the
decrease in the quantity of the other good as it moves along the
PPF.
• The slope of PPF measures the opportunity cost of producing goods
measured along X-axis.

20. Opportunity Costs in the U.S.
• The U.S. can produce 30 tons of beef
(and no vegetable) at B or 30 tons of
vegetables (and no beef) at V.
• An opportunity cost of producing one
ton of beef is 1 ton of vegetable.
30 vegetables/30 beef = 1 vegetables/beef
• An opportunity cost of producing one
ton of vegetables is 1 ton of beef.
30 beef/30 vegetables = 1 beef/vegetables
Vegetables(tons)
30
25
20
15
10
5
0 5 10 15 20 25 30
Beef (tons)
(a)
United States
A
B
V
Vegetables(tons)
12
18

21. Opportunity Costs in Mexico
• Mexico can produce 10 tons of beef
(and no vegetable) at b or 20 tons of
vegetables (and no beef) at v.
• An opportunity cost of producing one
ton of beef is 2 tons of vegetables.
20 vegetables/10 beef = 2 vegetables/beef
• An opportunity cost of producing one
ton of vegetable is 1/2 ton of beef.
10 beef/20 vegetables = 1/2 beef/vegetable
Z
30
25
20
15
10
0 5 10 15 20
v
b
Beef (tons)
(b)
Mexico
Vegetables(tons)
8
4

22. Comparative Advantage
• Opportunity cost of producing 1 ton of beef:
• 1 ton of vegetables in U.S.
• 2 tons of vegetables in Mexico
• The U.S. has a comparative advantage of producing beef over Mexico
• Opportunity cost of producing 1 ton of vegetable:
• 1 ton of beef in U.S.
• 1/2 ton of beef in Mexico
• The Mexico has a comparative advantage of producing vegetables over
the U.S.

23. Law of Comparative Advantage
• Law of comparative advantage: A country should specialize
in producing goods and services on which the country has a
comparative advantage.
• Country can gain from specializing in production of the goods
in which they have a comparative advantage and then trading.
• The U.S. should specialize in production of beef and produce
30 tons.
• Mexico should specialize in production of vegetables and
produce 20 tons.

24. Trade and Consumption
• Trade: the U.S. trades 10 tons of beef for 15 tons of
vegetable.
• The U.S. exports 10 tons of beef and imports 15 tons of
vegetables.
• After trade
• The U.S. can consume 20 tons of beef (= 30 – 10) and 15 tons of
vegetables (= 0 + 15)
• Mexico can consume 10 tons of beef (= 0 + 10) and 5 tons of
vegetables (= 20 – 15)

25. Gains from Trade
• Gains from Trade: After specialization and trade each country can
consume more than before trading.
• The U.S. can consume 2 extra-tons of beef (= 20 – 18) and 3 extra-tons
of vegetables (= 15 – 12) after trade as compared with no trade.
• Without trade the U.S. consume 18 tons of beef and 12 tons of vegetables.
• After trade the U.S. consume 20 tons of beef and 15 tons of vegetables.
• Mexico can consume 2 extra-tons of beef (= 10 – 8) and 1 extra-ton of
vegetables (= 5 – 4) after trade as compared with no trade.
• Without trade Mexico consume 8 tons of beef and 4 tons of vegetables.
• After trade Mexico consume 10 tons of beef and 5 tons of vegetables.

26. Comparative Advantage
LO40.2
Summary: Trade Based on comparative Advantage
40-26

27. Terms of Trade and Trade Possibilities Line
• Terms of trade: Rate of exchange of two goods
• 2 tons of beef = 3 tons of vegetables
or 1.5 tons of vegetables per ton of beef
• Trading possibilities line: a line starting from the
production combination point under specialization
with its slope equals terms of trade
• Both nation can choose any combination of two goods
along the trade possibilities line under the terms of
trade as own consumption point
LO40.2
40-27

28. Trading Possibilities Lines and the Gains from Trade
LO40.2
A
Z
A′
Z′
V
V′
v
b b′
Trading
possibilities line
Trading
possibilities
line
B
45
40
35
30
25
20
15
10
5
0 5 10 15 20 25 30
Vegetables(tons)
Beef (tons)
(a)
United States
Beef (tons)
(b)
Mexico
Vegetables(tons)
45
30
25
20
15
10
5
0 5 10 15 20
40-28
• After specialization, the
U.S. produce at B. It
produces only Beef.
• V’B line is a trade
possibilities line with
slope of 1.5 (terms of
trade). It starts from the
point of production B.
• After trade, the U.S.
can consume at A’. It is
on the trade
possibilities line. From
B to A’, -10 tons of Beef
and +15 tons of
vegetables.
• After specialization,
Mexico produce at v. It
produces only
vegetables.
• vb’ line is a trade
possibilities line with
slope of 1.5 (terms of
trade). It starts from the
point of production v.
• After trade, Mexico can
consume at Z’. It is on
the trade possibilities
line. From v to Z’, +10
tons of Beef and -15
tons of vegetables.

29. Gains from Trade
• Two nations mutually benefit from trade.
• A’ is better than A (more of both) for the U.S.
• Z’ is better than Z (More of both) for Mexico
• Both nations achieve consumption combinations beyond own PPF.
• A’ is outside of U.S. PPF.
• Z’ is outside of Mexico PPF.
• More efficient resource allocation in the world
• Two countries together produce more of both goods with specialization
(30 tons of Beef and 20 tons of vegetables) as compared with no trade
(18 + 8 = 26 tons of Beef and 12 + 4 = 16 tons of vegetables).
LO40.2
40-29

30. Increasing Costs and Trade
• Trade with increasing costs:
• Concave production possibilities curve (See Chapter 1)
• Resources not perfectly substitutable
• Some goods are land-intensive, others are labor or capital
intensive.
• Incomplete specialization
• Each country will choose a production point where it
produces both goods instead of producing only one good.
LO40.2
40-30

31. Case for Free Trade
• Promote efficiency on allocation of resources worldwide
• Each country gains from specialization and trade
• Promote competition
• Monopolist in domestic market must compete with foreign firms
in the world market.
• More competition means lower price and more efficient
allocation of resources.
• For each country, international trade will provide
• Variety of goods and services
• Higher standard of living (more consumption possible)
LO40.2
40-31

32. Supply and Demand Analysis of
International Trade
• Without international trade, the market must be at
equilibrium in each country
• If foreign price is different from domestic price
• Firms want to sell products at higher price, so firms exports to
the country where the market price is higher
• Households want to buy products at lower price, so households
imports from the country where the market price is lower
LO40.3
40-32

33. Supply and Demand Analysis of
International Trade
• If foreign price > domestic price
• Domestic firms can make more profits by selling to foreigners
• Domestic firms produce more and MC increases.
• Domestic price rises as the cost of production increases
• Domestic consumers purchase less. With more production, there will be
surplus of goods.
• Surplus will be exported to other country.
• Export supply: a relationship between price of good and a quantity of
exports.
LO40.3
40-33

34. Supply and Demand Analysis of
International Trade
• If foreign price < domestic price
• Domestic consumers can buy cheaply from foreign firms
• Domestic price falls as domestic firms try to compete with foreign firms.
• Domestic firms produce less as price decreases. With more quantity
demanded, there are shortage of goods.
• Shortage must be imported from other country.
• Import demand: a relationship between price of good and a quantity of
imports.
LO40.3
40-34

35. Supply and Demand Analysis of
International Trade
• At equilibrium
• Exporting country has surplus, while importing country has
shortage
• Trade must be balanced: Export must be equal to import
• Surplus in the exporting country must be equal to shortage in
the importing country
• Trade ends when the price in tow countries are the same.
LO40.3
40-35

36. U.S. Export Supply and Import Demand
LO40.3
1.25
1.00
.75
.50
0 50 100
Price(perpound;U.S.dollars)
Price(perpound;U.S.dollars)
$1.50
1.25
1.00
.75
.50
0 50 75 100 125 150
Quantity of aluminum
(millions of pounds)
(a)
U.S. domestic aluminum market
Dd
Sd
U.S.
export
supply
U.S.
import
demand
a
b
c
x
y
Surplus = 50
Surplus = 100
Shortage = 50
Shortage = 100
Quantity of aluminum
(millions of pounds)
(b)
U.S. export supply and import demand
$1.50
40-36
• At $1.00, no shortage
or surplus, so an export
supply and import
demand are 0 unit.
• At $0.75, there are 50
units of shortage which
must be imported, so
the import demand is
50 units.
• At $1.25, there are 50
units of surplus which
must be exported, so
the export supply is 50
units.

37. LO40.3
Canadian Export Supply and Import Demand
Dd
Sd
Canadian
export
supply
Canadian
import
demand
q
r
s
t
Surplus = 50
Surplus = 100
Quantity of aluminum
(millions of pounds)
(a)
Canada’s domestic aluminum market
Quantity of aluminum
(millions of pounds)
(b)
Canada’s export supply and import demand
$1.50
1.25
1.00
.75
.50
0
1.25
1.00
.75
.50
0
$1.50
50 75 100 125 150 50 100
Price(perpound;U.S.dollars)
Price(perpound;U.S.dollars)
Shortage = 50
40-37
• At $0.75, no shortage
or surplus, so an export
supply and import
demand are 0 unit.
• At $0.50, there are 50
units of shortage which
must be imported, so
the import demand is
50 units.
• At $1.00, there are 50
units of surplus which
must be exported, so
the export supply is 50
units.

38. Equilibrium World Price and Quantity of Exports and
Imports
LO40.3
$1.00
.75
.88
0 25
Quantity of aluminum
(millions of pounds)
Price(perpound;U.S.dollars)
Canadian
export
supply
e
U.S.
export
supply
U.S. import
demand
Equilibrium
Canadian
import demand
Import demand and Export supply
40-38
• Equilibrium: The U.S. import demand curve
crosses the Canada export supply curve at e.
• At e, import demand = export supply.
• The world equilibrium price is $0.88.
• At $0.88 there are 25 units of shortage in
the U.S. market.
• At $0.88 there are 25 units of surplus in
Canada.
• The U.S. will import 25 units from Canada.

39. Trade Barriers
• Trade Barriers: The government-imposed restraint on the
international trade of goods or services
• Tariffs: Excise taxes on imported goods
• Import quota: A limit on the quantity of goods imported
• Nontariff barrier (NTB): licensing, product standard, inspection,
and other government measures intended to restrict imports
• Voluntary export restriction (VER): Exporting country voluntarily
limits the amount of exports
• Export subsidy: Subsidies on export goods
LO40.4
40-39

40. Economic Impact of Tariffs and Import Quota
• Direct effects
• Increase in domestic price
• Decline in consumption (Loss of consumer surplus)
• Increase in domestic production and profits of domestic firms
• Decline in imports
• Tariff revenue (No revenue if import quota is imposed)
• Indirect effects
• Loss of efficiency (Producing at higher cost)
• Decline in exports (Trade is an exchange of goods produced)
• Decline in standard of living and welfareLO40.4
40-40

41. The Case for Protection
• Military self-sufficiency
• Diversification for stability
• Infant industry
• Protection against dumping
• Increased domestic employment
• Cheap foreign labor
LO40.5
40-41

42. Multilateral Trade Agreements
• World Trade Organization (WTO)
• European Union (EU)
• North American Free Trade Agreement (NAFTA)
• Trans-Pacific Partnership (TPP)
LO40.6
40-42

43. World Trade Organization (WTO)
• Established by Uruguay Round of GATT (General
Agreement on Tariffs and Trade).
• 164 member nations in 2018.
• Oversees trade agreements and rules on disputes.
• Critics argue that it may allow nations to circumvent
environmental and worker-protection laws.
LO40.6
40-43

44. European Union
• Initiated in 1958 as Common Market
• Abolished tariffs and import quotas between
member nations
• Established common tariff with nations outside the
EU
• Created Euro Zone with one currency
LO40.6
40-44

45. NAFTA
• Agreement between United States, Canada, and
Mexico
• Established a free trade zone between the countries
• Trade has increased in all countries
• Enhanced standard of living
• It was updated to USMCA (U.S.-Mexico-Canada
Agreement) in 2019
LO40.6
40-45

46. Trade Adjustment and Offshoring
• Trade Adjustment Assistance Act: Designed to help
individuals hurt by international trade.
• Offshoring of jobs: Shifting of work previously done
by American workers to workers abroad.
LO40.6
40-46

47. Last Word: Petition of the Candlemakers, 1845
• Petition of candlemakers asking for protection from
natural light producers such as the sun
• Tongue-in-cheek argument supporting the idea of
free trade
40-47