Absolute and Comparative Advantage

ChevalierSpring 2015

Warm-Up #12: Review Notes…

• List one economic cost and one social cost of economic instability. What are the three stabilization policies used to stabilize economic volatility? Explain the purpose of each.

The Key to Trade

• Specialization is the key to trade

• How do you know what a country specializes in? Where do you look?

• You look at its EXPORTS- the goods and services that it produces and then sells to other nations

The US and International Trade

• Int’l trade for the US is beneficial and necessary

• Goods and services are traded

• IMPORTS- goods and services that one country buys from other countries

• What would it be like with no imports?

The Basis for Trade

• Absolute Advantage-when a country can produce a product more efficiently (a greater amount) than can another country

• Sometimes, it is cheaper to import a product than to make it yourself

Total Output Before Specializing

Total Output After Specializing

Country A Country B Country A Country B

Coffee 20 + 5 =25

Cashews 4 + 1 =5

Coffee 40 + 0 =40

Cashews 0 + 6 =6

Comparative Advantage

• The ability to produce a product relatively more efficiently, or at a lower opportunity cost.

Barriers to International Trade

• Done through 2 major ways:

• Tariff-a tax placed on imports to increase their price in the domestic market (graph)

• Quota-a limit placed on the quantities of a product that can be imported-leads to a decrease in supply (graph)

2 Kinds of Tariffs

• Protective-a tariff high enough to protect less-efficient domestic industries• Real-life example

• Revenue-a tariff high enough to generate revenue for the government• Customs duties

Arguments For Protection

• National Defense (security)

• Becoming too dependent on foreign countries

• a nation should be self-sufficient in goods necessary for war

Promoting Infant Industries

• New and emerging industries within a country that need protection from other more established foreign industries

• Cars in Latin America

Protecting Domestic Jobs- employment protection argument

• Tariffs and quotas are necessary to protect American jobs that could go foreign if not protected.

• Complacency and improvement arguments

The Inevitable Argument

• all nations have barriers to trade so barriers should be erected

The Industry Argument

• Certain industries should be protected from competition

The Free Trade Movement

• World Trade Organization (WTO) 1947-

• Int’l agency that settles disputes, organizes trade negotiations, provides technical assistance for countries

NAFTA

• North American Free Trade Agreement

• All about cost-benefit analysis

• Free trade has allowed countries to capitalize on comparative advantages for everybody’s benefit

Trade Deficits and Surpluses

• Trade deficit-occurs when the value of the products it imports exceeds the value of products it exports.

• Trade Surplus-occurs when the value of products it exports exceeds the value of products it imports.

The International Value of the Dollar

• A stronger dollar compared to other currencies- results in a trade deficit; our products become more expensive worldwide.

• A weaker dollar compared to other currencies- results in a trade surplus, or balance of trade; our products become less expensive worldwide.