How comparative advantage leads to mutually beneficial international trade The sources of international comparative advantage Who gains and who loses from international trade, and why the gains exceed the losses How tariffs and import quotas cause inefficiency and reduce total surplus Why governments often engage in trade protection and how international trade agreements counteract this To First Active Learning To Video What you will learn in this chapter 1 INTERNATIONAL TRADE International trade improves the welfare of Chinese smart phone producers as well as American consumers. Back to Table of contents Image: Imaginechina/Corbis 2 INTERNATIONAL TRADE… …is more important for the U.S. than it used to be and is more important for some countries than others… Back to Table of contents PRODUCTION POSSIBILITIES AND COMPARATIVE ADVANTAGE REVISITED (Click here to skip this review section based on material found in Chapter 2) Trade follows the Ricardian model. (We assume that countries will specialize in goods they can produce more cheaply than other countries.) Autarky: a situation in which a country does not trade with other countries. Back to Table of contents COMPARATIVE ADVANTAGE AND GAINS FROM TRADE 100 0 100,000 100 0 25,000 50,0000 (a) U.S. production possibilities U.S. production and consumption without trade U.S. PPF China’s PPF Quantity of trucks Quantity of trucks Quantity of phones Quantity of phones (b) China’s production possibilities China’s production and consumption without trade 50,000 50 Since each country has a different opportunity cost, it makes sense to specialize and trade. 200 Back to Table of contents More trucks will be produced than before with the same resources (from 75,000 (50,000+25,000) to 100,000 trucks and from 150 (50 + 100) to 300 phones). Since the United States has the comparative advantage in trucks, it will specialize in trucks. And China has the comparative advantage in phones, so it will specialize in phones. COMPARATIVE ADVANTAGE AND GAINS FROM TRADE 100 0 100,000 100 0 25,000 50,0000 (a) U.S. production possibilities U.S. production and consumption without trade U.S. PPF China’s PPF Quantity of trucks Quantity of trucks Quantity of phones Quantity of phones (b) China’s production possibilities China’s production and consumption without trade 50,000 50 200 Back to Table of contents COMPARATIVE ADVANTAGE AND GAINS FROM TRADE Both countries will be happy to export their goods for any price ABOVE their cost of production and import for any price BELOW their cost of production. The United States will send trucks to China in return for phones… …and China will send phones to the United States in return for trucks. Both are happy with 1 truck trading for 2,000 phones. 100 0 100,000 100 0 25,000 50,0000 (a) U.S. production possibilities U.S. production and consumption without trade U.S. PPF China’s PPF Quantity of trucks Quantity of tr ...

1. How comparative advantage leads to mutually beneficial
international trade
The sources of international comparative advantage
Who gains and who loses from international trade, and why the
gains exceed the losses
How tariffs and import quotas cause inefficiency and reduce
total surplus
Why governments often engage in trade protection and how
international trade agreements counteract this
To First
Active Learning
To Video
What you will learn in this chapter
1
INTERNATIONAL TRADE
International trade improves the welfare of Chinese smart phone
producers as well as American consumers.
Back to Table of contents
Image: Imaginechina/Corbis

2. 2
INTERNATIONAL TRADE…
…is more important for the U.S. than it used to be and is more
important for some countries than others…
Back to Table of contents
PRODUCTION POSSIBILITIES AND COMPARATIVE
ADVANTAGE REVISITED
(Click here to skip this review section based on material found
in Chapter 2)
Trade follows the Ricardian model.
(We assume that countries will specialize in goods they can
produce more cheaply than other countries.)
Autarky: a situation in which a country does not trade with
other countries.
Back to Table of contents
COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities

3. U.S. production and consumption
without trade
U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities
China’s production and consumption
without trade
50,000
50
Since each country has a different opportunity cost, it makes
sense to specialize and trade.
200
Back to Table of contents
More trucks will be produced than before with the same

4. resources
(from 75,000 (50,000+25,000) to 100,000 trucks and from 150
(50 + 100) to 300 phones).
Since the United States has the comparative advantage in
trucks, it will specialize in trucks.
And China has the comparative advantage in phones, so it will
specialize in phones.
COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities
U.S. production and consumption
without trade
U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities

5. China’s production and consumption
without trade
50,000
50
200
Back to Table of contents
COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
Both countries will be happy to export their goods for any price
ABOVE their cost of production and import for any price
BELOW their cost of production.
The United States will send trucks to China in return for
phones…
…and China will send phones to the United States in return for
trucks.
Both are happy with 1 truck trading for 2,000 phones.
100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities

6. U.S. production and consumption
without trade
U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities
China’s production and consumption
without trade
50,000
50
200
62,500
75
U.S. consumption
with trade
China’s consumption
with trade
37,500
125

7. Back to Table of contents
Don’t confuse absolute and comparative advantage.
Just because the United States can produce more of both goods
doesn’t mean we’re better off without trade.
Pay attention to opportunity costs:
If it’s cheaper for China to produce phones than it is for the
United States, the United States will want to import phones
from China.
Back to Table of contents
8
PRODUCTIVITY AND WAGES AROUND THE WORLD
The real explanation for low wages in poor countries is low
overall productivity.
Back to Table of contents
Image: Penn world tables
9
SOURCES OF COMPARATIVE ADVANTAGE
Differences in climate

8. (Bananas grow better here.)
Back to Table of contents
SOURCES OF COMPARATIVE ADVANTAGE
Differences in factor endowments
(Canada can produce paper more cheaply because it’s
heavily forested.)
Factor abundance: the supply of a factor of production relative
to other factors.
How many forests does a country have compared to machines or
people?
Factor intensity: a measure of the quantity of a factor used in
comparison with other factors.
How much labor is used compared to natural resources or
machines?
Back to Table of contents
THE HECKSCHER-OHLIN MODEL
Bertil Ohlin
Eli Filip Heckscher
“A country that has an abundant supply of a factor of
production will have a comparative advantage in goods whose
production is intensive in that factor.”

9. Back to Table of contents
THE HECKSCHER-OHLIN MODEL IN ACTION
Who produces (labor-intensive) clothing? Countries with lots of
labor.
China and Bangladesh produce much of the world’s clothing.
Back to Table of contents
SOURCES OF COMPARATIVE ADVANTAGE
Differences in technology
Sometimes a country has developed a particular technology that
explains its comparative advantage.
Swiss watches, for example
Back to Table of contents
Increasing returns to scale also play a role in trade:
If an industry gets more efficient as it grows, then there will be
a few large producers…
and production may take place in only a few countries.
Back to Table of contents
HOW HONG KONG LOST ITS SHIRTS

10. Hong Kong lost its comparative advantage in garments.
Why?
It got better at other things too, which meant it was now giving
up MORE to produce garments.
To Next
Active Learning
Back to Table of contents
Image: Jennifer Thermes/Getty Images
16
SUPPLY, DEMAND, AND INTERNATIONAL TRADE
We can use the demand and supply model to determine:
the effects of free trade on:
domestic equilibrium price and quantity.
imports.
the effects of trade barriers on:
domestic equilibrium price and quantity.
imports.
Back to Table of contents
CONSUMER AND PRODUCER SURPLUS IN AUTARKY
Price of phones

11. Quantity of phones
Consumer surplus
Producer surplus
A
QA
PA
Domestic supply
Domestic demand
Back to Table of contents
THE DOMESTIC MARKET WITH IMPORTS
Price of phones
QA
Quantity of phones
A
PW
PA
Imports

12. Domestic quantity supplied with trade
Domestic quantity demanded with trade
QS
QD
Domestic supply
Domestic demand
Autarky price
World price
Back to Table of contents
Suppose this country opens to trade and that the world price is
equal to D. Then we know that they will:
import the number of bicycles between points R and S.
import the number of bicycles between points P and S.
export the number of bicycles between points P and R.
export the number of bicycles between points P and T.

13. To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents
THE EFFECTS OF IMPORTS ON SURPLUS
QA
A
PW
PA
W
X
Y
QS
QD
Price of phones
Quantity of phones
Domestic supply
Domestic demand

14. - X
X + Z
+ Z
Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
Z
Imports
Allowing imports increases total surplus.
Back to Table of contents
THE DOMESTIC MARKET WITH EXPORTS

15. Price of
phones
QA
Quantity of
phones
A
PA
PW
Autarky price
World price
Exports
Domestic quantity demanded with trade
Domestic quantity supplied with trade
QD
QS

16. Domestic supply
Domestic demand
Back to Table of contents
Suppose this country opens to trade and the world price is equal
to B. Then we know that they will:
import the quantity of bicycles between points M and W.
import the quantity of bicycles between points W and T.
export the quantity of bicycles between points M and W.
export the quantity of bicycles between points W and T.
To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents
THE EFFECTS OF EXPORTS ON SURPLUS
QA

17. A
PA
PW
Exports
W
X
Y
Z
QD
QS
Price of phones
Quantity of
phones
Domestic supply
Domestic demand
–
X
X
+
Z
+ Z

18. Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
Allowing exports increases total surplus.
Back to Table of contents
INTERNATIONAL TRADE AND WAGES
Broader effects of international trade: income distribution
Terms:
Exporting industries produce goods and services that are sold
abroad.
Import-competing industries produce goods and services that
are also imported.
Back to Table of contents
INTERNATIONAL TRADE AND WAGES
Does the combination of:
growing imports of labor-intensive products from newly
industrializing economies and
the export of high-technology goods
cause a widening wage gap between highly educated and less

19. well educated U.S. workers?
Many economists think so.
Back to Table of contents
THE EFFECTS OF TRADE PROTECTION
Policies that limit imports are known as trade protection or
simply as protection.
A tariff is a tax levied on imports.
Back to Table of contents
27
THE EFFECTS OF A TARIFF
A tariff has two effects:
↑ domestic production, ↓ domestic consumption.
The good is now produced by the higher-cost country.
Less is consumed → lower gains from trade.
Measuring the losses and wasted resources
Can we measure the value of wasted resources? Yes!
Back to Table of contents
28

20. THE EFFECT OF A TARIFF
PT
PW
World price
Tariff
QST
Imports after tariff
Price with tariff

21. Imports before tariff
QD
QDT
QS
Price of
phones
Quantity of
phones
Domestic supply
Domestic demand
The tariff pushes up the price, which reduces quantity demanded
and increases domestic quantity supplied.
Back to Table of contents
A TARIFF REDUCES TOTAL SURPLUS
+A
+C
–(A + B + C + D)
Government revenue

22. –(
B
+
D
)
Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
A
C
B
D
PT
PW

23. QST
QD
QDT
QS
Price of phones
Quantity of phones
Domestic supply
Domestic demand
Tariff
Imports after tariff
Imports before tariff
The tariff reduces consumer surplus,
increases producer surplus,
and creates deadweight loss.
creates new government revenue,
Back to Table of contents
If this country is an autarky, which is the area that corresponds
to consumer surplus? Which area corresponds to producer
surplus?
Consumer surplus = ACQ; producer surplus = CQIF.
Consumer surplus = ADS; producer surplus = DPE.

24. Consumer surplus = ACQ; producer surplus = CQE.
Consumer surplus = BMNC; producer surplus = CNOD.
To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents
THE EFFECTS OF AN IMPORT QUOTA
Import quota: legal limit on the quantity of a good that can be
imported.
Effect?
Same as tariff, except instead of government revenue, “quota
rents” will go to quota license holders (usually foreigners).
Back to Table of contents
TRADE PROTECTION IN THE UNITED STATES
Until recently, clothing and textiles were strongly protected
from import competition.
Now: the United States has very low tariffs, which increased the
benefit of trade (or, as in the graph, reduced the lost “welfare”).
Back to Table of contents

25. ARGUMENTS FOR TRADE PROTECTION
National Security
In times of national crisis or war the United States must be able
to rely on key domestic industries:
Oil
Steel
Defense
Food
Protection is required even during peacetime to ensure their
availability.
Back to Table of contents
34
ARGUMENTS FOR TRADE PROTECTION
Trade and domestic employment
Globalization will force some firms to lay off workers.
Even so, increased trade usually increases jobs in other
industries (exporters).
But: for workers who lose their jobs, switching industries can
be difficult and time-consuming.
Back to Table of contents
35

26. At TEDIndia, TED favorite Hans Rosling gives another lively
and humorous talk here and graphs global economic growth
since 1858. He also predicts the exact date that India and China
will outstrip the United States. (15:50 minutes)
Back to Table of contents
http://www.ted.com/talks/hans_rosling_asia_s_rise_how_and_w
hen.html
36
ARGUMENTS FOR TRADE PROTECTION
The infant industry argument:
Infant industry: New industries need a temporary period of
protection to develop.
Critique:
Hard for government to predict the best emerging technologies.
Difficult to become competitive when protected from
competition.
Many times politics determine which industries are granted
protection.
Back to Table of contents
37
Which argument against trade is the strongest in your opinion?
Trade reduces the number of jobs in the United States and

27. should therefore be limited.
It’s wrong to trade with countries that use child labor.
We need to keep some industries for reasons of national
security.
We need to protect certain industries while they develop.
To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents
INTERNATIONAL TRADE AGREEMENTS AND
THE WORLD TRADE ORGANIZATION
Countries care about each others’ trade policies…
International trade agreements: treaties in which a country
promises to reduce import tariffs in return for a promise by the
other country to do the same.
NAFTA (North American Free Trade Agreement): a trade
agreement between the United States, Canada, and Mexico.
EU (European Union): a customs union among 27 European
nations.
Global trade agreements
WTO (World Trade Organization): oversees international trade
agreements and rules on disputes between countries over those
agreements.
Back to Table of contents
NEW CHALLENGES TO GLOBALIZATION
Globalization and inequality: Outsourcing

28. Offshore outsourcing: hiring people in another country to
perform various tasks.
Sweatshop labor fallacy: It’s easy to get outraged about the low
wages paid to the person who made your shirt, harder to
appreciate how much worse off that person would be if denied
the opportunity to sell goods in rich countries’ markets.
Back to Table of contents
A tariff results in a higher:
I. consumer surplus.
II. producer surplus.
III. government revenue.
I and II only
II and III only
I and III only
I, II, and III
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents

29. RECENTLY IT WAS ANNOUNCED
THAT TWO MAJOR HOSPITAL
SYSTEMS WOULD BE MERGING
THEIR SERVICES IN TO ONE ENTITY.
BOTH ARE COMPRISED OF
MULTIPLE HOSPITAL UNITS
AND SPECIALTY CLINICS.
WHILE ON THE SURFACE, THIS HAS BEEN TOUTED
AS AN ECONOMICAL MOVE WITH SUBSTANTIAL
SAVINGS TO BOTH PARTIES AND THE POTENTIAL
TO SOLIDIFY THEIR MARKET SHARE, THERE ARE AS
YET MANY BARRIERS TO OVERCOME.
FOR INSTANCE, ONE SYSTEM HAS ITS ROOTS
AS A CATHOLIC ENTITY, WHILE THE OTHER
BEGAN WITH ITS ORIGINS AS A JEWISH
FACILITY.
JOURNAL TOPIC
POST YOUR RESPONSE ON
THE UNIT 4 JOURNAL AREA.
Given these circumstances, what form or
model(s) of leadership would you bring to
bear? Describe in detail the steps you
would take to redirect the mission and
vision of this new emerging entity.
THE MEDICAL STAFF IS
DIVIDED ON WHETHER THE

30. MERGER IS GOOD FOR
PATIENTS AND THEIR
PRACTICES.
BOTH GROUPS OF EMPLOYEES ARE UNDERSTANDABLY
UNSETTLED
AS IT IS UNCERTAIN WHO OF THE SENIOR
ADMINISTRATIVE
STAFF WILL REMAIN. THE ORGANIZATIONAL CULTURE
OF BOTH
INSTITUTIONS IS ALSO OF MAJOR CONCERN.
Slide Number 1Slide Number 2Slide Number 3
How comparative advantage leads to mutually beneficial
international trade
The sources of international comparative advantage
Who gains and who loses from international trade, and why the
gains exceed the losses
How tariffs and import quotas cause inefficiency and reduce
total surplus
Why governments often engage in trade protection and how
international trade agreements counteract this
To First
Active Learning
To Video
What you will learn in this chapter
1

31. INTERNATIONAL TRADE
International trade improves the welfare of Chinese smart phone
producers as well as American consumers.
Back to Table of contents
Image: Imaginechina/Corbis
2
INTERNATIONAL TRADE…
…is more important for the U.S. than it used to be and is more
important for some countries than others…
Back to Table of contents
PRODUCTION POSSIBILITIES AND COMPARATIVE
ADVANTAGE REVISITED
(Click here to skip this review section based on material found
in Chapter 2)
Trade follows the Ricardian model.
(We assume that countries will specialize in goods they can
produce more cheaply than other countries.)
Autarky: a situation in which a country does not trade with
other countries.
Back to Table of contents

32. COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities
U.S. production and consumption
without trade
U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities
China’s production and consumption
without trade
50,000
50

33. Since each country has a different opportunity cost, it makes
sense to specialize and trade.
200
Back to Table of contents
More trucks will be produced than before with the same
resources
(from 75,000 (50,000+25,000) to 100,000 trucks and from 150
(50 + 100) to 300 phones).
Since the United States has the comparative advantage in
trucks, it will specialize in trucks.
And China has the comparative advantage in phones, so it will
specialize in phones.
COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities
U.S. production and consumption
without trade

34. U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities
China’s production and consumption
without trade
50,000
50
200
Back to Table of contents
COMPARATIVE ADVANTAGE AND GAINS FROM TRADE
Both countries will be happy to export their goods for any price
ABOVE their cost of production and import for any price
BELOW their cost of production.
The United States will send trucks to China in return for
phones…
…and China will send phones to the United States in return for
trucks.
Both are happy with 1 truck trading for 2,000 phones.

35. 100
0
100,000
100
0
25,000
50,0000
(a) U.S. production possibilities
U.S. production and consumption
without trade
U.S.
PPF
China’s
PPF
Quantity of
trucks
Quantity of
trucks
Quantity of phones
Quantity of phones
(b) China’s production possibilities
China’s production and consumption
without trade
50,000
50
200

36. 62,500
75
U.S. consumption
with trade
China’s consumption
with trade
37,500
125
Back to Table of contents
Don’t confuse absolute and comparative advantage.
Just because the United States can produce more of both goods
doesn’t mean we’re better off without trade.
Pay attention to opportunity costs:
If it’s cheaper for China to produce phones than it is for the
United States, the United States will want to import phones
from China.
Back to Table of contents
8
PRODUCTIVITY AND WAGES AROUND THE WORLD
The real explanation for low wages in poor countries is low
overall productivity.

37. Back to Table of contents
Image: Penn world tables
9
SOURCES OF COMPARATIVE ADVANTAGE
Differences in climate
(Bananas grow better here.)
Back to Table of contents
SOURCES OF COMPARATIVE ADVANTAGE
Differences in factor endowments
(Canada can produce paper more cheaply because it’s
heavily forested.)
Factor abundance: the supply of a factor of production relative
to other factors.
How many forests does a country have compared to machines or
people?
Factor intensity: a measure of the quantity of a factor used in
comparison with other factors.
How much labor is used compared to natural resources or
machines?
Back to Table of contents

38. THE HECKSCHER-OHLIN MODEL
Bertil Ohlin
Eli Filip Heckscher
“A country that has an abundant supply of a factor of
production will have a comparative advantage in goods whose
production is intensive in that factor.”
Back to Table of contents
THE HECKSCHER-OHLIN MODEL IN ACTION
Who produces (labor-intensive) clothing? Countries with lots of
labor.
China and Bangladesh produce much of the world’s clothing.
Back to Table of contents
SOURCES OF COMPARATIVE ADVANTAGE
Differences in technology
Sometimes a country has developed a particular technology that
explains its comparative advantage.
Swiss watches, for example
Back to Table of contents
Increasing returns to scale also play a role in trade:

39. If an industry gets more efficient as it grows, then there will be
a few large producers…
and production may take place in only a few countries.
Back to Table of contents
HOW HONG KONG LOST ITS SHIRTS
Hong Kong lost its comparative advantage in garments.
Why?
It got better at other things too, which meant it was now giving
up MORE to produce garments.
To Next
Active Learning
Back to Table of contents
Image: Jennifer Thermes/Getty Images
16
SUPPLY, DEMAND, AND INTERNATIONAL TRADE
We can use the demand and supply model to determine:
the effects of free trade on:
domestic equilibrium price and quantity.
imports.
the effects of trade barriers on:
domestic equilibrium price and quantity.
imports.

40. Back to Table of contents
CONSUMER AND PRODUCER SURPLUS IN AUTARKY
Price of phones
Quantity of phones
Consumer surplus
Producer surplus
A
QA
PA
Domestic supply
Domestic demand
Back to Table of contents
THE DOMESTIC MARKET WITH IMPORTS
Price of phones
QA
Quantity of phones

41. A
PW
PA
Imports
Domestic quantity supplied with trade
Domestic quantity demanded with trade
QS
QD
Domestic supply
Domestic demand
Autarky price
World price
Back to Table of contents

42. Suppose this country opens to trade and that the world price is
equal to D. Then we know that they will:
import the number of bicycles between points R and S.
import the number of bicycles between points P and S.
export the number of bicycles between points P and R.
export the number of bicycles between points P and T.
To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents
THE EFFECTS OF IMPORTS ON SURPLUS
QA
A
PW
PA

43. W
X
Y
QS
QD
Price of phones
Quantity of phones
Domestic supply
Domestic demand
- X
X + Z
+ Z
Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
Z
Imports
Allowing imports increases total surplus.

44. Back to Table of contents
THE DOMESTIC MARKET WITH EXPORTS
Price of
phones
QA
Quantity of
phones
A
PA
PW
Autarky price
World price
Exports

45. Domestic quantity demanded with trade
Domestic quantity supplied with trade
QD
QS
Domestic supply
Domestic demand
Back to Table of contents
Suppose this country opens to trade and the world price is equal
to B. Then we know that they will:
import the quantity of bicycles between points M and W.
import the quantity of bicycles between points W and T.
export the quantity of bicycles between points M and W.
export the quantity of bicycles between points W and T.
To Next
Active Learning
LEARN BY DOING: PRACTICE QUESTION
Back to Table of contents

46. THE EFFECTS OF EXPORTS ON SURPLUS
QA
A
PA
PW
Exports
W
X
Y
Z
QD
QS
Price of phones
Quantity of
phones
Domestic supply
Domestic demand

47. –
X
X
+
Z
+ Z
Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
Allowing exports increases total surplus.
Back to Table of contents
INTERNATIONAL TRADE AND WAGES
Broader effects of international trade: income distribution
Terms:
Exporting industries produce goods and services that are sold
abroad.
Import-competing industries produce goods and services that
are also imported.

48. Back to Table of contents
INTERNATIONAL TRADE AND WAGES
Does the combination of:
growing imports of labor-intensive products from newly
industrializing economies and
the export of high-technology goods
cause a widening wage gap between highly educated and less
well educated U.S. workers?
Many economists think so.
Back to Table of contents
THE EFFECTS OF TRADE PROTECTION
Policies that limit imports are known as trade protection or
simply as protection.
A tariff is a tax levied on imports.
Back to Table of contents
27
THE EFFECTS OF A TARIFF
A tariff has two effects:
↑ domestic production, ↓ domestic consumption.
The good is now produced by the higher-cost country.
Less is consumed → lower gains from trade.

49. Measuring the losses and wasted resources
Can we measure the value of wasted resources? Yes!
Back to Table of contents
28
THE EFFECT OF A TARIFF
PT
PW
World price
Tariff
QST

50. Imports after tariff
Price with tariff
Imports before tariff
QD
QDT
QS
Price of
phones
Quantity of
phones
Domestic supply
Domestic demand
The tariff pushes up the price, which reduces quantity demanded
and increases domestic quantity supplied.
Back to Table of contents
A TARIFF REDUCES TOTAL SURPLUS
+A

51. +C
–(A + B + C + D)
Government revenue
–(
B
+
D
)
Gain
Loss
Changes in surplus
Consumer surplus
Producer surplus
Change in total surplus
A
C
B
D

52. PT
PW
QST
QD
QDT
QS
Price of phones
Quantity of phones
Domestic supply
Domestic demand
Tariff
Imports after tariff
Imports before tariff
The tariff reduces consumer surplus,
increases producer surplus,
and creates deadweight loss.
creates new government revenue,

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If this country is an autarky, which is the area that corresponds
to consumer surplus? Which area corresponds to producer
surplus?
Consumer surplus = ACQ; producer surplus = CQIF.
Consumer surplus = ADS; producer surplus = DPE.
Consumer surplus = ACQ; producer surplus = CQE.
Consumer surplus = BMNC; producer surplus = CNOD.
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THE EFFECTS OF AN IMPORT QUOTA
Import quota: legal limit on the quantity of a good that can be
imported.
Effect?
Same as tariff, except instead of government revenue, “quota
rents” will go to quota license holders (usually foreigners).
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54. TRADE PROTECTION IN THE UNITED STATES
Until recently, clothing and textiles were strongly protected
from import competition.
Now: the United States has very low tariffs, which increased the
benefit of trade (or, as in the graph, reduced the lost “welfare”).
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ARGUMENTS FOR TRADE PROTECTION
National Security
In times of national crisis or war the United States must be able
to rely on key domestic industries:
Oil
Steel
Defense
Food
Protection is required even during peacetime to ensure their
availability.
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34
ARGUMENTS FOR TRADE PROTECTION
Trade and domestic employment
Globalization will force some firms to lay off workers.
Even so, increased trade usually increases jobs in other
industries (exporters).

55. But: for workers who lose their jobs, switching industries can
be difficult and time-consuming.
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35
At TEDIndia, TED favorite Hans Rosling gives another lively
and humorous talk here and graphs global economic growth
since 1858. He also predicts the exact date that India and China
will outstrip the United States. (15:50 minutes)
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http://www.ted.com/talks/hans_rosling_asia_s_rise_how_and_w
hen.html
36
ARGUMENTS FOR TRADE PROTECTION
The infant industry argument:
Infant industry: New industries need a temporary period of
protection to develop.
Critique:
Hard for government to predict the best emerging technologies.
Difficult to become competitive when protected from
competition.
Many times politics determine which industries are granted
protection.

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37
Which argument against trade is the strongest in your opinion?
Trade reduces the number of jobs in the United States and
should therefore be limited.
It’s wrong to trade with countries that use child labor.
We need to keep some industries for reasons of national
security.
We need to protect certain industries while they develop.
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INTERNATIONAL TRADE AGREEMENTS AND
THE WORLD TRADE ORGANIZATION
Countries care about each others’ trade policies…
International trade agreements: treaties in which a country
promises to reduce import tariffs in return for a promise by the
other country to do the same.
NAFTA (North American Free Trade Agreement): a trade
agreement between the United States, Canada, and Mexico.
EU (European Union): a customs union among 27 European
nations.

57. Global trade agreements
WTO (World Trade Organization): oversees international trade
agreements and rules on disputes between countries over those
agreements.
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NEW CHALLENGES TO GLOBALIZATION
Globalization and inequality: Outsourcing
Offshore outsourcing: hiring people in another country to
perform various tasks.
Sweatshop labor fallacy: It’s easy to get outraged about the low
wages paid to the person who made your shirt, harder to
appreciate how much worse off that person would be if denied
the opportunity to sell goods in rich countries’ markets.
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A tariff results in a higher:
I. consumer surplus.
II. producer surplus.
III. government revenue.
I and II only
II and III only
I and III only
I, II, and III
LEARN BY DOING: PRACTICE QUESTION

58. Back to Table of contents