International trade occurs when goods and services are exchanged between countries. Countries specialize in producing goods where they have a comparative advantage, allowing for increased productivity and economic interdependence. David Ricardo developed the theory of comparative advantage to show that even if a country is less efficient in all products, it can still gain from trade by specializing in the product where its opportunity costs are lowest. Trade barriers like tariffs and quotas restrict trade but also raise prices, while free trade allows for lower consumer prices and more competition between producers.

1. Chapter 17: International Trade
 International trade is the voluntary exchange of goods
and services between individuals and businesses located
in different countries.
 People expect to gain by trading with other people. They hope
to receive a good or service that is more valuable than whatever
they trade away.
 People do not trade when the good or service being offered is of
less value than the good or service they are asked to exchange.

2. Resource Distribution
and Specialization
 A country’s production is the result of its natural
resources, human capital, physical capital and
entrepreneurship.
 Production factors affect what individuals and businesses
produce.
 Specialization allows businesses to increase productivity and
profit.
 Specialization leads to economic interdependence among
countries.

3. David Ricardo: The Theory of
Comparative Advantage
 Economist David Ricardo (1772-
1823) is responsible for the theory
of comparative advantage.
 This theory is the backbone of modern
free trade.
 It shows that a country’s ability to
produce more of a certain product in a
given time does not mean that it can
produce that product more efficiently.

4. Absolute Advantage v.
Comparative Advantage
 Absolute advantage is the ability of one country to make
a product more efficiently than another country.
 For example, a country that requires 10 hours to make one ton
of steel is more efficient that a country that requires 12 hours to
make one ton of steel.

5. Absolute Advantage v.
Comparative Advantage
 Comparative advantage is the idea that one country will
specialize in what it can produce at a lower opportunity
cost than any other country.
 For example, a country whose opportunity cost for making 10
tons of steel per day is 50 tons of iron ore has the comparative
advantage over the country that produces 11 tons of steel and
77 tons of iron ore per day.
 Even though the second country has the absolute advantage in
both products, the first country’s opportunity cost (5 to 1) is
lower than the second country’s opportunity cost (7 to 1).
 The law of comparative advantage evaluates a country’s
production according to its efficiency and its opportunity costs.

6. How Comparative Advantage Works
 The U.S. can produce 500 tires or 75 bushels of corn using
the same resources.
 The U.S. may choose to produce fewer tires or fewer bushels of
corn, and not specialize and trade.
 If the U.S. decides to specialize and trade, it will produce either
tires OR corn, and will trade with a country that specializes in
the other product.

7. Comparative Advantage Problem
South Korea
A B C D E F
Radios 30 24 18 12 6 0
Chemicals 0 6 12 18 24 30
*No trade, column C
United States
R S T U V W
Radios 10 8 6 4 2 0
Chemicals 0 4 8 12 16 20
*No trade, column S

8. Comparative Advantage Problem
1. Determine Ratios
South Korea
1 Radio = 1 Chemical
1 Chemical = 1 Radio
United States
1 Radio = 2 Chemicals
1 Chemical = ½ Radio

9. Comparative Advantage Problem
2. Determine the country that has the comparative
advantage for each product.
SK: 1 Radio = 1 Chemical
US: 1 Radio = 2 Chemical
SK: 1 Chemical = 1 Radio
US: 1 Chemical = ½ Radio
*SK makes radios, US makes chemicals

10. Comparative Advantage Problem
3. Determine the terms of trade.
1 Radio = between 1 Chemical & 2 Chemical
1 Chemical = between ½ Radio and 1 Radio

11. Comparative Advantage Problem
4. Determine the amount that is produced of each good if
there is not trade and specialization.
18 + 8 = 26 Radios
12 + 4 =16 Chemicals

12. Comparative Advantage Problem
5. Determine the amount that is produced if there is trade
and specialization.
SK makes only radios: 30
US makes only chemicals: 20

13. Comparative Advantage Problem
6. Determine the total gain from trade for each product.
30 - 26 = 4 radios
20 - 16 = 4 chemicals

14. International Trade Affects the
National Economy
 Imports and exports affect a country’s economy.
 When a country exports a product, the market expands to
include other countries and the demand for the product
increases. As demand increases, so does the product’s price. The
increased demand also results in more jobs and increased
income in the country that makes the product.
 An increase in a country’s imports cause the supply of those
goods to increase in the country. When supply increases,
consumers have a greater selection of goods and pay lower
prices. The increased competition gives domestic producers
more incentives to become more efficient.
 An increase in exports benefits producers and an increase
in imports benefits consumers.

15. Trade Barriers
 Most countries implement some laws that limit trade in an
effort to protect domestic jobs and industries from foreign
competition. These laws are called trade barriers.
 These trade barriers lead to higher prices, and sometimes other
countries respond to these barriers by enacting trade barriers of
their own.
 Trade barriers are often based on political agendas, not on
economics.

16. Types of Trade Barriers
 Quotas
 A quota is a limit on the amount of a product that can be
imported.
 Quotas help domestic producers by restricting foreign supply
and keeping prices high.
 Tariffs
 A tariff is a fee charged for goods imported into a country.
 There are two types of tariffs: revenue tariffs and protective
tariffs.
 Revenue tariffs are used to increase tax revenues.
 Protective tariffs are used to protect domestic producers by
raising the prices of imported goods.

17. Types of Trade Barriers
 Voluntary Export Restraint
 In an effort to avoid a quota or a tariff, a country may choose to
limit the amounts of its exports to a specific country.
 Embargo
 An embargo is a law that cuts off trade with a specific country,
usually for political reasons.
 Informal Trade Barrier
 These are indirect trade restrictions that are designed to make it
more difficult to import goods into a country (licenses,
environmental regulations, safety measures, etc.).

18. The Impact of Trade Barriers
 Trade barriers have two major effects.
 Prices for products increase or remain high. For example, when
a tariff is implemented on a product, the producer of that
product cannot compete with domestic producers. This makes
it easier for domestic producers to increase their prices as well.
 Trade barriers sometimes cause trade wars, which occur when
countries impose severe trade barriers on each other’s products.

19. Arguments for Protectionism
 Protectionism is the use of trade barriers between
countries to protect domestic industries.
 There are several arguments in favor of protectionism.
 Trade barriers are needed to protect domestic jobs.
 Trade barriers are needed to protect infant industries.
 Trade barriers are needed to protect national security.

20. Foreign Exchange
 Countries have worked out a system to exchange
currencies between buyers and sellers. The system’s two
key elements are the foreign exchange market and the
foreign exchange rate.
 Over the past 130 years, countries have use three different
types of exchange rate systems.
 1879-1944: most countries used the gold standard—this was a
fixed exchange rate system.
 1944-1971: most countries used the Bretton Woods system—a
fixed exchange rate system that was tied to the dollar.
 1971-present: most countries use a managed float system—a
flexible exchange rate system with occasional currency
interventions by central banks.

21. Appreciation of Currency
 A currency appreciates when its demand in the world
market increases.
 Caused by an increase in the demand for a country’s goods,
services, or financial assets.
 Fewer units of the currency are needed to buy a unit of some
other currency.
 Prices of the country’s goods and services are now relatively
more expensive.

22. Depreciation of Currency
 A currency depreciates when its supply in the world
market increases.
 Caused by a decrease in the demand for a country’s goods,
services, or financial assets.
 More units of the currency are needed to buy a unit of some
other currency.
 Prices of the country’s goods and services are now relatively
cheaper.

23. Determinants of Exchange Rates
 Changes in Tastes
 Japanese electronic equipment increases in popularity in the
United States.
 Japanese yen appreciates
 U.S. dollar depreciates
 Change in Income Level
 The U.S. economy is expanding rapidly (GDP increases, thus
income level increases) and the British economy is stagnant.
 Americans buy more British products.
 British pound appreciates
 U.S. dollar depreciates

24. Determinants of Exchange Rates
 Change in Inflation Rate
 The inflation rate in Mexico is zero percent and 5 percent in Canada.
 Canadians will buy more Mexican goods.
 Mexican peso appreciates
 Canadian dollar depreciates
 Change in Interest Rate
 The interest rate in India increases while the interest rate in
South Korea remains the same.
 Investors deposit more money in interest-bearing accounts in
Indian banks.
 Indian rupee appreciates
 South Korean won depreciates

25. Balance of Trade
 The balance of trade is the difference between a country’s
imports and exports.
 The balance of trade is expressed in a worksheet called the
balance of payments.
 The balance of payments is a record of all the transactions
that occurred between individuals, businesses, and
government of one country and the rest of the world.

26. Trade Deficits & Surpluses
 Trade Deficit: occurs when the value of a country’s imports
exceeds the value of its exports.
 Trade Surplus: occurs when the value of a country’s
exports exceeds the value of its imports.