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R. GLENN
HUBBARD
O’BRIEN
ANTHONY PATRICK
Macroeconomics
FOURTH EDITION
CHAPTER
7
Comparative Advantage and the
Gains from International Trade
Chapter Outline and
Learning Objectives
7.1
The United States in the
International Economy
7.2
Comparative Advantage in
International Trade
7.3
How Countries Gain from
International Trade
7.4
Government Policies That
Restrict International Trade
7.5
The Arguments over Trade
Policies and Globalization
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The United States in the International Economy
7.1 LEARNING OBJECTIVE
Discuss the role of international trade in the U.S. economy.
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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.
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The Importance of Trade to the U.S. Economy
Figure 7.1 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.
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U.S. International Trade in a World Context
Figure 7.2
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.
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Figure 7.3
International Trade as a Percentage of GDP
International trade is still less important to the United States than to most other countries.
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Comparative Advantage in International Trade
7.2 LEARNING OBJECTIVE
Understand the difference between comparative advantage and absolute
advantage in international trade.
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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 7.1 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
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Absolute advantage The ability to produce more of a good or service than
competitors when using the same amount of resources.
Table 7.2 The Opportunity Costs of Producing Cell Phones and Tablet Computers
Opportunity Costs
Cell Phones
Tablet Computers
Japan
0.5 tablet computer
2 cell phones
United States
2 tablet computers
0.5 cell phone
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.
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How Countries Gain from International Trade
7.3 LEARNING OBJECTIVE
Explain how countries gain from international trade.
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Autarky A situation in which a country does not trade with other countries.
Table 7.3 Production without Trade
Production and Consumption
Cell Phones
Tablet Computers
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.
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Table 7.4
Gains from Trade for Japan and the United States
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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.
Does Anyone Lose as a Result of International Trade?
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.
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.
MyEconLab Your Turn: Test your understanding by doing related problem 3.12 at the end of this chapter.
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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.
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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.
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Government Policies That Restrict International Trade
7.4 LEARNING OBJECTIVE
Analyze the economic effects of government policies that restrict international trade.
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Free trade Trade between countries that is without government restrictions.
Figure 7.4
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.
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Figure 7.5
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.
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Tariffs
Figure 7.6
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.
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.
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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.
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Figure 7.7
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.
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The High Cost of Preserving Jobs with Tariffs and Quotas
Table 7.5 Preserving U.S. Jobs with Tariffs and Quotas Is Expensive
Product
Benzenoid chemicals
Luggage
Softwood lumber
Dairy products
Frozen orange juice
Ball bearings
Machine tools
Women's handbags
Canned tuna
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Number of Jobs
Saved
216
226
605
2,378
609
146
1,556
773
390
Cost to Consumers per Year
for Each Job Saved
$1,376,435
1,285,078
1,044,271
685,323
635,103
603,368
479,452
263,535
257,640
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Table 7.6 Preserving Japanese Jobs with Tariffs and Quotas Is Also Expensive
Product
Rice
Natural gas
Gasoline
Paper
Beef, pork, and poultry
Cosmetics
Radio and television sets
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Cost to Consumers per
Year for Each Job Saved
$51,233,000
27,987,000
6,329,000
3,813,000
1,933,000
1,778,000
915,000
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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.
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The Arguments over Trade Policies and Globalization
7.5 LEARNING OBJECTIVE
Evaluate the arguments over trade policies and globalization.
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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.
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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.
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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.
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“Old-Fashioned” Protectionism
Protectionism The use of trade barriers to shield domestic firms from foreign
competition.
Protectionism is usually justified on the basis of one of the following arguments:
• 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.
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Dumping
Dumping Selling a product for a price below its cost of production.
Positive versus Normative Analysis (Once Again)
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:
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.
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